Nervous Decisions are Costing Investors Money
The stock market is always moving up or down. The aim of all investors is to make money, but a recent study found that the roller-coaster nature of the market can lead some investors to make rash decisions that may cost them a lot of money.
The annual Dalbar study looks at returns over a 20-year period, and their latest report concluded that over that time, there have been more ups than downs in the market. In 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
The report defined nine of the irrational investment behaviors that have the most negative effect:
- Loss Aversion – The fear of loss leads to a withdrawal of capital at the worst possible time. Also known as “panic selling.”
- Narrow Framing – Making decisions about on part of the portfolio without considering the effects on the total.
- Anchoring – The process of remaining focused on what happened previously and not adapting to a changing market.
- Mental Accounting – Separating performance of investments mentally to justify success and failure.
- Lack of Diversification – Believing a portfolio is diversified when in fact it is a highly correlated pool of assets.
- Herding– Following everyone else. Leads to “buy high/sell low.”
- Regret – Not performing a necessary action due to the regret of a previous failure.
- Media Response – The media has a bias to optimism to sell products from advertisers and attract view/readership.
- Optimism – Overly optimistic assumptions tend to lead to rather dramatic reversions when met with reality.
Perhaps the best approach to take is the “sensible middle ground of investing” – pursue the fundamental investment principles, regardless of market conditions. Invest in a wide range of investments based on real value that are designed to pay dividends or interest, and stay the course despite the market ups and downs.
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