What’s the biggest obstacle to your ability to invest successfully? Is it the ups and downs of the financial markets? Political events? The fact that you weren’t born rich? Actually, the chief hurdle you face is something over which you have control: your own emotions.
Your emotions can lead to a variety of ill-advised investment behaviors, such as these:
• Cutting losses – Declines in the financial markets can lead some investors to try to “cut their losses” by selling investments whose price has declined. Yet, when prices have dropped, it may actually be a good time to buy investments, not sell them, especially when the investments are still fundamentally sound.
• Chasing performance – In the investment world, the flip side of “fear” is “greed.” Just as some investors are propelled by fear of loss, others are motivated by quick, big gains. They may pursue “hot” investments, only to be disappointed when the sizzle quickly fizzles. Instead of trying to “score” that one big winner, you may be better off spreading your investment dollars among a range of vehicles – stocks, bonds, government securities, certificates of deposit (CDs) and so on. While diversification can’t guarantee a profit or protect against loss, it may help reduce the impact of market volatility on your portfolio.
• Focusing on the short term – When the market is down, you might get somewhat upset when you view your monthly investment statements. But any individual statement is just a snapshot in time; if you were to chart your investment results over a period of 10, 15 or 20 years, you’d see the true picture of how your portfolio is doing – and, in all likelihood, that picture would look better than a statement or two you received during a down market. In any case, don’t overreact to short-term downturns by making hasty “buy” or “sell” decisions. Instead, stick with a long-term strategy that’s appropriate for your goals, risk tolerance and time horizon.
• Heading to the investment “sidelines” – Some people get so frustrated over market volatility that they throw up their hands and head to the investment “sidelines” until “things calm down.” And it’s certainly true that, when owning stocks, there are no guarantees; you do risk losing some, or all, of your investment. But if you jump in and out of the market to “escape“ volatility, you may take on an even bigger risk – the risk of losing some of the growth you’ll need to reach your goals. Consider this: If you had invested $10,000 in a package of stocks mimicking the S&P 500 in December 1979, your investment would have grown to more than $426,000 by December 2013. But if you had missed just the 10 best days of the market during that time, your $10,000 would only have grown to less than $206,000 – a difference of about $220,000, according to Ned Davis Research, a leading investment research organization. The bottom line? Staying invested over the long term can pay off. (Keep in mind, though, that the S&P 500 is an unmanaged index and isn’t meant to depict an actual investment. Also, as you’ve no doubt heard, past performance is not a guarantee of future results.)
Our emotions are useful in guiding us through many aspects of our lives, but when you invest, you’re better off using your head – and not your heart.