How to avoid three emotional investing mistakes
Published March 17, 2020
Sandy
What would you assume is the biggest barrier to your investment success? While market volatility and investment performance can affect your success toward your important long-term goals, your own emotions can become the biggest roadblock.
Hello, and welcome to Edward Jones Perspective; I’m Sandy Miller. Investment Strategist Scott Thoma is here with three mistakes people often make when their emotions get in the way of their investment strategy – and how you can avoid them. Scott, what’s first on your list?
Scott
Well as we all know, money can be an emotional topic. But unfortunately, we may tend to fall prey to many mistakes based on our emotions. For example, too often investors are tempted to head to the sidelines when the news looks bad. Whether it’s the economy, tariff or trade war concerns, or market fluctuations, there is no shortage of headlines that could distract you from your long-term goals.
Some investors try to avoid potential stock market declines by selling investments and moving to cash. But in order to time the market successfully, you have to get two decisions right: when to get out, and when to get back in. Getting one right is difficult, and getting two right is nearly impossible.
Other investors may hold too much in cash, thinking they are avoiding risk. But this could actually increase the risk of not having enough growth in their portfolio to meet their goals or outpace inflation.
Sandy
So staying invested requires you to ride out any potential declines, obviously. Should investors just ignore these headlines, then?
Scott
Sandy, that may not be a bad idea. When negative events occur, the media often use extreme language for dramatic effect. The key is, do these ever-changing headlines really affect your long-term goals? It’s important to take a step back and review your strategy with your financial advisor before making moves based on the latest headline.
Sandy
I get it – after all, investors have successfully navigated through tough periods in the markets before. What’s your second piece of advice?
Scott
Well, Sandy, when the media hype the latest “hot” investment or highlight “sharp” declines in the market, investors are often tempted to chase the winners and sell the losers. But this emotional response can lead to buying investments at market peaks and selling them at the bottoms.
Sandy
So then, investors are doing the opposite of the adage “buy low and sell high,” aren’t they? This sounds like a recipe for underperformance.
Scott
You are correct. Chasing performance – in other words, buying what just did well and selling what is down – can seriously affect the diversification of your portfolio and, as you said, can be a recipe for underperformance. Instead of trying to find the next hot investment, you should stay invested with a diversified portfolio specifically tailored for your situation and long-term goals.
It’s important to understand the purpose of your investments – that each one may be there for a reason – which may help you avoid chasing performance. For example, if you’re retired, some investments provide income today, while others help provide income down the road. But each serves a critical role in ensuring your money lasts as long as you need it.
Since each one serves a different role, each may be outperforming and underperforming at different times – and this may actually be by design. While diversification cannot guarantee a profit or protect against loss in a declining market, it can help smooth out market ups and downs, so don’t chase performance.
Sandy
This is all great information, Scott. What’s the third mistake investors should avoid?
Scott
While it’s important to look at the long term, day-to-day fluctuations can obscure your view of success. For example, in 2008, some investors sold off after their portfolios fell from all-time highs. But if they had looked at their long-term performance instead, they may still have been on track toward their important long-term goals.
Sandy
It sounds like investors should definitely take a step back and assess the situation before they act.
Scott
That’s right, Sandy. While market declines can be unpleasant, they’re in fact a normal part of investing. In fact, on average, the stock market has a decline of 10% about once a year. Your measurement of success should be your progress toward your long-term goals rather than any day-to-day fluctuations.
Sandy
Any final word for investors?
Scott
Sure. A short-term market decline or the latest media headline doesn’t change your long-term goals. It helps if you can review your goals and objectives, recognize behaviors that could cause trouble, and as always, work with your financial advisor to help you focus on your progress toward your goals and avoid making emotional investment decisions.
Sandy
Thanks, Scott. For more information on these and other summertime tips, contact your local Edward Jones financial advisor.
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While market volatility and investment performance can affect your success toward your important long-term goals, your own emotions can become the biggest roadblock. Here are three mistakes people often make when their emotions get in the way of their investment strategy – and how you can avoid them.
Mistake No. 1: Heading to – or staying on – the sidelines
Too often investors are tempted to head to the sidelines when the news looks bad. Whether it’s the economy, tariff or trade war concerns, or market fluctuations, there is no shortage of headlines that could distract you from your long-term goals.
Some investors try to avoid potential stock market declines by selling investments and moving to cash. But in order to time the market successfully, you have to get two decisions right: when to get out, and when to get back in. Getting one right is difficult, and getting two right is nearly impossible.
Other investors may hold too much in cash, thinking they are avoiding risk. But this could actually increase the risk of not having enough growth in their portfolio to meet their goals or outpace inflation.
What to do instead
When negative events occur, the media often use extreme language or highlight low periods in the past for dramatic effect. The key is, do these ever-changing headlines really affect your long-term goals? Investors have successfully navigated tough periods in the markets before. You’re better off focusing on your long-term goals and not the latest headline.
Mistake No. 2: Chasing performance
When the media hype the latest “hot” investment or highlight “dramatic” declines in the market, investors are often tempted to chase the winners and sell the losers. But this emotional response can lead to buying investments at market peaks and selling them at the bottoms – a recipe for underperformance.
What to do instead
Instead of trying to find the next hot investment, you should stay invested with a diversified portfolio specifically tailored for your situation and long-term goals.
Also, be sure you understand the purpose of your investments. For example, if you’re retired, some investments provide income today, while others help provide income down the road. But each serves a critical role in ensuring your money lasts as long as you need it.
Since each one serves a different role, each may be outperforming and underperforming at different times. While diversification cannot guarantee a profit or protect against loss in a declining market, it can help smooth out market ups and downs, so don’t chase performance.
Mistake No. 3: Focusing on the short term
While it’s important to look at the long term, day-to-day fluctuations can obscure your view of success. For example, in 2008, some investors sold off after their portfolios fell from all-time highs. But if they had looked at their long-term performance instead, they may still have been on track toward their important long-term goals.
What to do instead
Your measurement of success should be your progress toward your long-term goals rather than any day-to-day fluctuations. It helps if you can review your goals and objectives, recognize behaviors that could cause trouble, and as always, work with your financial advisor to help you focus on your progress toward your goals and avoid making emotional investment decisions.
Important information:
This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situations.