Humans are emotional beings – there’s no avoiding the fact. Being in touch with your emotions is all well and good when it comes to healthy relationships, but when it comes to managing your money, it could land you in hot water. Here are five investing mistakes we can avoid by being less emotional…
Trading too frequently
Buying and selling investments at the right time can be a great way to take advantage of market conditions, but if your instinct is to sell your investments the moment that prices start to dip, you could be heading for trouble. Not only are you failing to allow for the natural market ups and downs, but you run the risk of trading costs (the charges you pay to the broker each time you buy and sell individual investments) eating into any returns you do make. Research suggests that men are a third (35%)1 more likely to act irrationally in this way, running the risk of higher overall losses in the long run. Studies also show that overconfident investors tend to buy and sell more frequently and neglect to do proper research, which can lead to rash decisions and taking undue risk.
1. Fidelity, Aug 2017 - https://www.fidelity.com/about-fidelity/individual-investing/better-investor-men-or-women
Not diversifying enough
When it comes to building an investment portfolio, it’s generally a good idea to pick a large number of investments (e.g. shares, bonds, property, commodities, and alternatives) and a wide range of markets and regions (e.g. the UK’s FTSE 100 or US-based S&P500) – this is known as diversification. Failing to diversify may be a result of our ‘emotional biases’ – a tendency to favour things we’re most familiar with. This instinct sees many investors favouring ‘home’ markets – e.g. UK investors buying FTSE 100 investments – rather than spreading their money more widely to avoid being hit too hard if one market has a particularly bad week. Being creatures of habit, we can also tend to stick to investments we know, rather than taking a risk on those we don’t – known as the ‘endowment effect’. Whatever the reasons that lead to investors holding poorly-diversified portfolios, refusing to spread out your money could lead to greater risks and potential losses.
Listening to the noise
As social animals, we have a tendency to follow what others do without necessarily thinking about whether it’s the best idea for us. This so-called ‘herd mentality’ can also be found in the investing world. For instance, when stock markets start to fall, the media is quick to publish headlines with emotive words like ‘stocks crash’ alongside images of brokers panic selling stocks. Naturally, our instinct is to do the same, without thinking about the possible repercussions of our fear-based decisions and forgetting the often-shared advice that you should ignore the noise and focus on the long-term.
Making decisions based on past performance
Learning from the past can be a good way to move forward in life, but when it comes to investing, there’s no guarantee that history will repeat itself. Picking investments simply because they’ve performed strongly in the past, without doing suitable research into the possible future prospects of your buying could hurt your returns in the long run. Nobody can accurately predict future market activity (if they could they’d be the richest person on the planet), so you might as well read tea leaves.
Thinking you know best
Investors convinced they know best will typically try to ‘outsmart’ the market by picking what they think are the best times to be invested (known as ‘timing the market’). Put simply, they’re guessing. When they think markets are likely to fall, they start selling their investments or stop buying and vice versa. When they feel prices have reached their lowest levels, they will buy investments with the strong belief the market will bounce back. However, unless you have a fully-functioning crystal ball, it’s unlikely you’ll get it right most of the time. In fact, evidence suggests that by jumping in and out, you tend to miss out on some of the best days to be invested, and after all is said and done, you’re better off just staying in and riding out the bumps.
Ways to avoid investing mistakes
Do your research
Facts are a better friend than intuition when it comes to making choices. Before picking your investments and building your portfolio, make sure to do your research. Instead of listening to your gut and relying on past performance, spend time reading companies’ annual reports and watching the news before making your investing decisions.
Spread out your risk
Diversify your investments. ‘How?’, you ask. It simply means spreading out your money by holding a variety of investments from different markets. This way, if some investments perform badly, they can be balanced out by others that are doing ok. An easy way to diversify is to invest in funds which buy you hundreds or thousands of different investments all at once.
Seeing markets drop can be stressful but keeping your nerve in such situations could prevent you from making mistakes. Healthy markets have ups and downs so, as an investor, it’s important to learn to live with market bumps and accept that your investments can go down from time to time. Sometimes the best thing you can do when markets fall is stay away from the news and resist the urge to sell.
” Investing should be more like watching paint dry or watching grass grow. If you want excitement take $800 and go to Las Vegas. “As Paul Samuelson’s quote suggests, investing should be approached with a long-term vision. Holding your investments over many years can help smooth out the ups and downs of the market and potentially give your money more time to grow thanks to the power of compounding. Evidence shows that thinking long-term tends to pay off. Indeed, people investing for any 10-year period in the FTSE100 index since 1984 will have had an 88%2 chance of making a positive return on their money.
2: Bloomberg data
Get help from investing experts
If you don’t want to risk making mistakes with your decisions, you could let investing experts pick your investments and manage your portfolio on your behalf, using their years of experience and extensive knowledge of markets to give you the best chance of a positive return. This way, you not only get to make your money work harder, but you can focus on the things you enjoy, while someone else does all the hard work.
Figures in this blog are based on past performance and past performance is not a reliable indicator of future results.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
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The comments and opinions expressed in this article are the author's own and should not be taken as financial advice from Wealthify.