“Emotional investing” is the term used when investors make drastic decisions about their money and assets based on how they feel the market is currently performing instead of focusing on their long-term performance. Following your feelings is usually counterproductive as your emotions usually lead you to choose the wrong action at the wrong time. Additionally, it can be costly because there are usually charges associated with carrying out buy/sell transactions and if you respond to every change in the market, it increases your fees.
Your first step to becoming a better investor is to understand how your emotions may have affected previous investment decisions. By becoming aware of these pitfalls, you can drastically reduce the frequency of errors and greatly enhance your returns.
The five most common behavioural pitfalls that investors are likely to experience are:
This happens when investors are overly optimistic about their ability to choose the best securities as well as the best times to enter or exit a position
- Loss aversion
Loss aversion refers to an investor’s preference to avoid incurring losses because the associated pain is more intense than the reward felt from a gain. Investors tend to experience this more intensely during periods of market volatility.
- Chasing past performance
Many investors fall prey to this pitfall because they select securities that are performing well because they believe that the securities’ recent performance will continue to offer robust returns. This, however, is far from the truth as studies have shown that recent performance has almost no correlation to future performance.
- Timing the market
Investors who use this strategy buy and sell stocks based on expected price fluctuations, i.e., if they can correctly guess when the market will go up and down. However, this is almost impossible to achieve on a regular basis.
- Failure to rebalance
It is essential for investors to rebalance their portfolios on a regular basis to keep their asset allocation on track and provide the necessary protection from market volatility. Due to prevailing market conditions, some investors stray from their predetermined allocation and can also fail to rebalance on schedule.
All markets go through cycles which are practically impossible to predict. However, studies have shown that successful investors who have cultivated the following disciplined investing habits reach their long-term financial goals:
- Follow a structured long-term investment plan.
This is developed by selecting the appropriate investment vehicles that complement your risk attitude and will help guide you to achieve your predetermined goals.
- Track your progress so you can always be aware of how your investments are performing.
This will help you to determine if you need to make any adjustments to your portfolio.
- Seek expert advice.
Financial advisors can offer you professional expertise as well as insight you may not have and can help you to evaluate the available information to make the best investment decisions.
- Know and understand the value of doing nothing at all.
There is a saying that time in the market, rather than timing the market, is what leads to a satisfactory result. Therefore, if you make fewer changes, you will hopefully make fewer mistakes as well. This, in turn, will allow your investments to benefit from sustained compounding, which is one of the best drivers of returns.