There’s a lot at stake when investing, which is why emotional decision-making is common for so many individual investors. Are you making any of these behavioral investing mistakes?
As investors, it’s difficult to separate our emotions when making financial decisions, particularly investment decisions. While your emotions will impact your decision process, allowing them to dictate short-term investment decisions can be costly. Avoid these five behavioral mistakes we see investors make.
1. Attempting to “time the market”
Many investors believe that they can predict market movement, but perfectly timing markets, which requires getting it right twice, at the entry and exit points, is a near-impossible task. While the traditional guidance is to buy low and sell high, investors do the exact opposite, getting spooked and selling during downturns, or getting caught up in the excitement and buying when a security is going up.
Our team recently looked at the importance of investing with a long-term approachversus attempting to time the market. Since 2000, even investing at the worst S&P 500 timing provides significant market upside compared to leaving cash in three-month U.S. Treasury bills! If you believe the market will go up over the next 30 years, you’re better off buying today rather than waiting for the “perfect” time to buy.
2. Chasing returns
Investors often base investment decisions on past performance, ignoring the forward-looking data — for example, buying a stock because it’s gone up for the last several years. Don’t let a fear of missing out drive an investing mistake; just because a particular security has done well in the past doesn’t mean that it will perform well in the future, so be sure to pay attention to the forward-looking information.
3. Lack of diversification
Are you putting all your eggs in one basket? An investment portfolio should be diversified, or spread out among different companies, industries, types of investment, and so on. A lack of diversification in a portfolio leaves investors subject to larger “swings” in investment returns, especially during times of increased volatility. If you’re only invested in one industry (or one company, as someone who receives equity as part of their compensation may be), your portfolio performance depends on how well that one small market segment or company is performing.
Most investors feel negative market performance to a much greater extent than positive performance — in other words, we often experience the pain of the lows more intensely than the joy of the highs — which can lead to emotional decision-making. Proper diversification helps to limit the downside and increase the potential for future upside by avoiding an ill-advised run to safety.
4. Avoiding the “tough conversations”
Addressing uncomfortable planning items can be difficult to discuss, but avoiding them can be extremely costly. Items such as overspending or estate planning will have an indirect impact on the ongoing investment decision one needs to make. Perhaps you’re spending too much and you’re going to run out of money much sooner than you planned, or you’re not saving enough to keep up with your goals. These problems are hard to talk about — especially if you don’t know how to solve them — and sweeping them under the rug is all too common. Advisorscan play a key role in not only initiating and steering those tough conversations, but developing solutions so the issues don’t spiral further out of control.
5. Not having a strategy or investment policy in place
Often, investors haven’t identified a strategy or investment policy that aligns with their overarching goals and risk tolerance. It’s not surprising — unless you have an education in proper investing, it’s very hard to understand how to put a strategy together, and modern technology makes it easy to jump into the market without much information at all. Naturally, this can lead to a lot of mistakes.
For example, investors often look at each account separately rather than looking at their entire portfolio. Even when investors do have some part of a strategy, like an asset allocation target, they may not have the knowledge to make adjustments should their portfolio become unbalanced. Or, say an investor finds themselves with excess cash from an investment, earnings, bonus, or inheritance. Without a cash-on-hand policy, you might find yourself not knowing what to do with that cash or just not making a decision. That may not sound like a problem, but a proper investment strategy would ensure that cash is working for you — either by earning an appropriate yield, paying down debt or invested — not sitting in a savings account, missing out on returns.
Identifying an overall investment policy and sticking to it through routine rebalancing is paramount to long-term investing success by minimizing emotion in decision-making while quickly identifying the right moves to make throughout market cycles.
Maximize your investment with an experienced advisor
Have you made any of these mistakes? Don’t beat yourself up — there’s a reason they’re so common. There’s a lot at stake when investing, and very few guarantees, so making emotional decisions is only natural, but getting it wrong could mean missing out on potential upside and growth. That’s why it’s so helpful to have an expert advisor to guide you toward maximizing your investment. An advisor will help you create, execute, and continuously monitor an investment strategy to keep you on track, reduce emotional decisions, and provide clarity to your financial plan.
