Investors are prone to making irrational decisions. The simple truth is that what feels good, or what satisfies an immediate impulse, is not always compatible with generating positive, long-term returns.
But while investors know the general guidelines for building and growing wealth, they’re often blind to their own recurring mistakes. The 5 W’s of bad investing behavior are some of the most-common behavioral quirks that can keep investors from realizing their financial goals. The solution is to know which characteristics plague your portfolio and to take the appropriate steps to address them.
Winging it. A shocking number of investors – some studies indicate more than 70% — have no financial plan. Without a clear understanding of what you’re investing for, it’s difficult to create a discipline that will allow you to reach those goals. And discipline is paramount. It’s what helps investors make the choices that support their desired outcomes. Without a plan and a disciplined approach, many investors end up off track. Factors that are critical to consider when creating a disciplined financial plan are cash flow, spending rate, risk appetite, time horizon and liquidity.
Weighting the Winners. Say you have a simplified portfolio of 50% stocks held in the SPDR S&P 500 and 50% bonds held in iShares Barclays Aggregate Bond ETF as of January 1. If at the end of the year, stocks are up and bonds are down, you’re more inclined to dump the bonds and move your money into stocks. But if at the end of the following year, bonds are up and stocks are down, you’re likely to get back into bonds.
What makes investors take this all or nothing approach – 100% stocks or 0% stocks? It’s the desire to build positive returns, certainly, but merely chasing the winners is not sustainable. Dumping the “losers” in your portfolio essentially means giving up the opportunity to realize the winners of tomorrow.
Consider establishing an investment policy statement for your portfolio in order to diversify your assets and to better understand the limits of what you are willing to expose yourself to. Ideally, this investment policy statement would include periodic rebalancing to your losers while trimming your winners, which will help keep your overall risk level in check. You should also consider incorporating guidelines for diversification. This can help smooth out the bumps in the road and keep you from panicking during the inevitable ups and downs of the market.
Watching the Markets Intensely. There is such a thing as too much information. From 24/7 cable news to monthly investor publications, the sheer amount of facts and figures investors can access is enormous. But how much is really helpful?
Hot new investments are constantly being discussed and promoted, from Internet stocks such as ETF PowerShares (Nasdaq: QQQ) in the late ‘90s to real estate ETFs such as iShares Dow Jones US Real Estate (NYSE: IYR) in the mid ‘00s, to gold ETFs such as SPDR Gold Shares today (NYSE: GLD). It’s not as simple as saying you should avoid whatever is popular at the moment, but you should at the least look to limit the amount of exposure in your portfolio to these higher volatility areas, while approaching any “hot” new ideas with a healthy amount of skepticism.
Studies from Dalbar show that investors have the habit of piling into whatever is working at the moment only to bail once something new comes along. This creates a significant gap between market returns and investor returns. If this characterizes your own behavior, consider building a diversified portfolio for the core 80-90% of your assets, while limiting headline-grabbing and higher risk themes to 10% at a time in order to avoid too much damage should your positions turn against you.
Further, all of this information seldom puts investors’ minds at ease. Too much information can lead investors to focus on all the wrong things, while distracting them from their long-term plan. If Goldman Sachs is espousing stocks, that doesn’t mean that’s where all of your money needs to go. A winning investment strategy for a particular day or week might not sustain a lifetime of wealth creation and preservation.
Waffling Between Trading and Investing. The distinction is simple: trading results in instant gratification while investing is building wealth over a lifetime. Too many investors struggle with delayed gratification – they become obsessed with lottery-style investments that promise immediate returns. The trouble is, investors have proven to be pretty bad at timing the market.
Being a long-term investor is a challenge, and it shouldn’t be about entertainment. It is, at its core, hard work – planning for the expected and making provisions for what can’t be anticipated. As a long term investor, it’s also important to understand the hurdles you face. Based on historic averages, stock investors should expect 5% declines three times a year, 10% declines once a year and 20% declines every two and a half years. That’s a tremendous number of opportunities to misread the information and shoot yourself in the foot.
Everyone wants to get rich quickly, but if you think about the hard work that has gone into getting your investments to grow to where they are now, and looking at the timeframe you still have to work with, you’ll think about how you invest a lot differently.
Worrying About Your Neighbors’ Investments. This isn’t just about keeping up with the Jones’ portfolio. Far too many investors become obsessed with what their neighbors, friends, or highly visible benchmarks are doing, and so tend to lose sight of their own big picture. Today, everyone is focused on Apple, but that doesn’t mean the tech giant is the only place to invest your money.
The problem is that your neighbor is not you. They might be 10 years from retirement, while you have 30 more to go. Their appetite for risk might be far greater than your own. Similarly, tracking the S&P 500 doesn’t get you any closer to understanding how your bonds are performing.
Neighbors also tend to selectively share their winners while hiding losers in order to make themselves appear more successful than they really are. It is a concept called winning tickets. If someone goes to the race track, they like to show off their winners while hiding their losers under the bleachers. The lesson is: always take what you hear with a grain of salt.
There will always be someone doing better or claiming to do better than you. The key is to remain confident and comfortable that the path you are on is the correct one for you, given your personal risk/return threshold and what type of investor you would like to be. I read a great quote from Charlie Munger of Berskshire Hathaway: when asked about what made him a great investor, he said “indifference.” This applies to neighbors as well as benchmarks.
In order to correct these bad behaviors, investors must first be honest with themselves. If you’re prone to following the herd, or marching to the tune of the latest stock-picking genius, then take steps to address those pitfalls. Find a financial professional who can help you understand your own impulses, while building a fundamental plan and process that lets you achieve long-term success.
From forbes.com
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