On one hand, investing is rather simple. There are basic rules and tenets, and over a very long period of time your results can be fairly predictable. That is unless, of course, you let your emotions get the best of you. For while the S&P 500 has averaged an annual return of 10.35% over the past 30 years, the average equity investor has earned only 3.66% over the same time period1. Carl Richards famously coined this the “behavior gap”, as it is our behaviors as investors that tend to have the biggest impact on our investment returns. Below are some of the common investor behaviors most likely to negatively impact your portfolio. Are you guilty of any of these?
Selling low and buying high is one of the sneakiest traps – it’s something we are sure others are terribly guilty of but would never do ourselves. And yet it happens to the best of us at times. We watch the markets get shaky and drop as they have over the past few weeks and wonder if we are taking on too much risk. Contrast this to a couple of months ago when the markets were continuously hitting fresh highs every day and we were thinking we might be missing out on some of those easy returns. Believe it or not, the markets are much “safer” right now than they were before this volatility began. When you feel the urge to sell or buy investments, ask yourself if your emotions are factoring into the equation.
When our time horizon is short (for bonds this means less than 3 years, for stocks it’s less than 10 years), we will tend to overreact. Overreacting looks like either thinking you need to make a change to your investments, or thinking you are a genius for causing your investments to increase. The first likely isn’t true, and the second definitely isn’t. So don’t go reading too much into short-term movements. Short-term movements are mainly just noise and the collective emotions of the masses making waves in the markets.
This one is particularly tempting for 401(k) investors. Employers often do a great job of narrowing down the universe of mutual funds into 10-20 selections to choose from, giving their employees a variety of asset classes to choose from. Unfortunately, far too often we load up on the few funds that have performed the best over the past several years. If anything, statistics show that these are the funds most likely to underperform in the years to come (the obvious exception to this is the fact that stock funds will outperform bond funds over the long haul). So if you have a micro-cap Russian technology fund in your line-up that increased by 78% last year, please don’t think that will automatically happen every year. Instead, choose your allocation using a disciplined, diversified approach.
“There is a time for everything,
and a season for every activity under the heavens” Ecclesiastes 3:1
God has made this world not to go in a straight line, but full of curves, twists and seasons. This is plain and obvious, and we will do well to remember this with our investments as well. While I’ve never met anyone to challenge this thought, there are many who try to fight against it. How do we do this? Market timing. Or as you might prefer to call it – avoiding the upcoming correction. But they are the same thing. When we try to avoid the natural cycles and rhythms, we tend to cause ourselves anxiety, confuse stewardship with predicting the future, and usually become one of the statistics of the Behavior Gap.
Related to the above, there is usually something plain and obvious to us that no one else can plainly see. If you are one of the millions of people who was “this close” to buying bitcoins when they were $1, you know what I’m talking about. Usually this results in buying a handful of individual stocks whose brand names we like, and then getting emotionally tied to them. Of these stock picks, we tend to have one amazing stock, one dog, and a bunch of average joes. Guess which one we talk about at the company Christmas party? We then hold onto this amazing stock until it comes crashing back to earth and we can then talk about how we were “this close” to selling it at the very top.
A friend of mine calls these news shows “financial pornography”. We can get addicted to financial news because it offers the promise of getting ahead, avoiding the impending crash, and easy ways to wealth. In reality, these shows prey on their watchers anxiety and fear, and they get paid a lot of money for knowing how to entice you to watch just a little more. And it’s terribly confusing because there are multiple experts who take the same data and come to completely opposite conclusions.
There is often a direct correlation between the amount of financial news watched and the number of financial mistakes investors make. The best thing you can do is just turn it off, because it is all short-term information that neglects cycles and makes you think you’re smarter than everybody else.
So which of these investor mental mistakes ring out as painfully true? The best thing you can do is be self-aware of the places you are tempted to let your emotions get the best of your investments and combat them with the truth. Symptoms of financial mental health will be a freedom from anxiety, a disciplined investment plan, and an acknowledgement that we are simply stewards of Someone Else’s property.
1https://www.qidllc.com/wp-content/uploads/2016/02/2016-Dalbar-QAIB-Report.pdfBACK TO NEWS