Our friends at Dr. Wealth here in Singapore have a unique take on a lot of issues in the world of investing. Below they talk about a theme that we’ve also often touched upon: The role of emotions in investing. (Here you can download a free special report about how to avoid some of the biggest investment pitfalls that lurk when your emotions get the best of you in investing.)
Are you making these 6 common investing mistakes?
By Dr. Wealth
Most people think that investing is about making rational decisions. But the reality is that many – if not most – investment decisions are governed by emotion.
Below we take a look at 6 of the most common investing mistakes that happen when you let your emotions get the best of you.
1. Buying high, selling low
Although most people understand the logic of buying low and selling high in the stock market, many investors are actually doing the exact opposite.
There are two reasons why this happens:
Most investors are uncomfortable with risk. As a result, many investors buy when prices are high (when others are – and thus it feels safe), and selling when the market drops (due to fear).
But the bandwagon effect can be lethal to your returns. Doing what everyone else is doing is a recipe for disaster. Often, the best investment decisions are those that go against the grain – this is called contrarian investing.
One specific type of contrarian investing is known as turnaround investing. Turnaround investing focuses on what happens when companies announce results. If bad news about a company causes its stock price to plummet, the crowd will “jump on the bandwagon” and sell the stock. That often means the true value of the stock is higher than the current market price. The majority ignore the true value, however, because they’re focused on the bad news associated with the company.
So avoid being part of the herd. If everyone you know is talking stocks and the newspapers are publishing overly optimistic news, it may be time to consider the contrarian view and be conservative.
b. Not tracking your portfolio
Most investors only realize that they are buying high and selling low when they start looking after their investments. If you think you’re buying low and selling high, but don’t have the numbers to show it, you should start keeping better track of your investments. It might sound obvious… but it’s not.
And stop trying to time the market for the best entry point. Instead, you should focus on time in the market. Otherwise, you might miss out on the best weeks of market performance. (We wrote more about why you should stay invested, here.)
2. Becoming emotionally attached to their investments
It’s a bad idea to let your emotions lead you to hold investments that are falling in value.
Maybe the asset (whether it’s a stock or a property or something else) was given to you when a family member passed away… or they are shares from a company you once worked for… or it’s the first stock you ever bought.
Whatever the reason, make sure you’re holding onto it for one reason: profit. You should never allow your emotional attachment to an investment keep you from selling and reinvesting into a better performer. Sentimental value never made anyone rich. (And in fact, it’s done a lot to make people less rich.)
3. Having a short-term investment horizon
American economist Paul Samuelson said, “Investing should be like watching paint dry or watching grass grow. If you want excitement… go to Las Vegas.” If you view your investments as a way to get rich quick, like Las Vegas (or, closer to home, Macau), you’ll just wind up enriching the house – not yourself.
Investment decisions should only be made with the aim of growing your wealth over the long term. While short-term performance is exciting, and trying to get the timing right can be fun, it’s difficult and time consuming to replicate. And you’ll probably get it wrong more often than you get it right.
What’s more, your investment horizon can make a huge difference to your returns.
Historical data have shown that over 1 month, major indices reported losses 40 percent of the time. When you stretch that time period to over 5 years, the losses drop to 15 percent of the time. And if you extend it even further, say, to over 20 years, it drops to a negligible percentage value.
If you focus solely on what an investment could do in the short term, then you are missing out on what it could potentially do in the long term – and that leads to a potential drop in the gains you could make.
4. Being too active in the stock market
It’s easy to get caught up with constantly tinkering with your portfolio.
This is especially easy to do when markets are volatile. Investors tend to feel that they need to be doing something to maximize their profits, or protect themselves if things look shaky.
But if you have an investment portfolio that is structured and follows a clear strategy, there really is no need to make a change just for change’s sake.
Sometimes, the best thing you can do is… nothing.
5. Not managing your money efficiently
When it comes to thinking about money, many people compartmentalize different financial needs.
They mentally allocate money to daily expenses, savings, holiday needs, and the like. But while it may be easier to mentally account for money this way, it’s usually an inefficient way of dealing with finances.
For example, some people put more money in their savings account than they use to pay off credit cards. But savings accounts have low interest rates – while credit cards have high rates. Often, it’s better to use your savings to reduce your credit card balance, as you’ll save money not paying high interest.
Don’t put your money in a silo. Put it where it works best.
6. Not viewing investments in the context of a portfolio
It is easy to focus only on the individual stocks. However, without an overall plan, you could be missing out on the bigger picture, and on making bigger gains.
When you look at your investments as a portfolio, something that looks like a bad decision, on its own, could actually be a positive one. Taking a small loss on a bad investment may allow you to shift capital to a better-performing investment.
Share prices are always fluid, especially when markets are volatile. To protect your wealth against individual stock movements within your portfolio, try to diversify, that is, make sure your assets aren’t correlated. (Read more about how to do this… here.)
While you can’t fully control what your investments will do in the future, at least you should prepare yourself by avoiding mistakes.
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