“Successful investing requires you to do the most counter-intuitive thing in the world, something that totally runs against human nature and the fight-or-flight instinct that’s been bred into our species over eons – being excited for down-markets and bad news.” Josh Brown The Reformed Broker
Investors have a talent for buying into investments at the top and selling at the bottom. Many investors get caught up in media hype or fear and buy or sell investments at the peaks and valleys of the cycle. Why does this type of emotional investing happen and how can investors avoid both the euphoric and depressive investment traps? That is the million dollar question!
The behavior of investors has been well documented and there are numerous theories that attempt to explain the regret and overreaction that buyers and sellers experience when it comes to money, potential gains, and losses. The average investor is putting their hard-earned money at stake and, while hoping for a gain, wants to protect that cash against losses. Cue the emotional attachment.
When the stock market is in the middle of a rally, investors get increasingly greedy and look jealously at the past returns that stocks have produced. Perhaps they are viewing the gains that were missed because they sat on the sidelines waiting for the waves to get less choppy. When the stock market falls, fear and anger replace greed and jealousy, which drives investors to sell their investments even after they have already lost some of their value, locking in permanent losses.
It is difficult to keep emotions from affecting investing decisions, but we have listed three key steps you can take to minimize the emotional impact and stay on track.
1. Make investing a regular habit rather than a response to changing market conditions. If you set up automatic purchases to invest money on a regular basis, regardless of whether the stock market is up or down, you will not need to pay as much attention to fluctuations in the markets. Participating in the highs and lows on a steady, repetitive basis can help investors stay the course.
2. Have a long-term investing plan that includes specific goals. If the only number you focus on is your current balance in your account and monitor that daily with a short-term mentality, you may fall into the trap of making long-term decisions with short-term thinking. Focus on concrete goals with intermediate targets along the way. This will allow you to track performance over time and keep a long-term perspective.
3. Understand your personal tolerance for risk and use past experience as a guide to how you’re likely to respond to future market moves. If you’ve panicked in the past when the market dropped, work with your advisor to adjust your strategy to one that will reflect your lower tolerance for risk and volatility.
“…the dominant determinant of long-term, real-life return is not investment performance but investor behavior.”
— Nick Murray