Far too often, investors use their gut reactions to invest. For those saving for retirement, this is like bulking up on junk food. The end result is not pretty.
That’s not to say that we should deny our emotions when dealing with money. It’s a good idea to be fearful about market risk and losing money. But you just should act on those fears with a long-term plan that you adjust once a year.
Thanks to the field of behavioral economics, we don’t have to listen to out gut. We can use our brains to derail the worst part of emotional investing. If we become more rational, we will avoid mistakes that ultimately lose money over time.
According to Justin Goldstein, director of financial wellness for Bronfman E.L. Rothschild:
“Emotions can have a powerful impact on financial decisions and can lead to errors resulting in losses or missed opportunities over a lifetime of investing. Understanding how many of us make decisions can help individuals avoid errors and instill the discipline needed to build and maintain wealth.”
Here are some common gut reactions that lead to money-losing decisions and how they can be avoided:
1) Myopia. This common mistake is more than being near-sighted. It’s over-focusing on recent results. What happened today? Did the stock market go up or down? Did that mutual fund do well in the last quarter?
Look at long-term results and the overall performance of the stock market over time. If you want to be in the market, invest for the long term and understand the short-term risks: Don’t try to time the ups and downs.
2) Herd Behavior. Sure, a lot of people bail and go to cash when the stock market hits the skids. But that’s the best time to buy, not sell! Those who do best over time are buying when others are bailing.
Look at Warren Buffett. He was snatching up companies at the trough in 2008. Keep investing if you believe in stock profits long term. Don’t follow the herd over the cliff.
3) Anchoring. This is one of the most common mistakes investors make. The reasoning is that if a stock hits a certain price, you will buy or sell. That’s irrational, since you almost never know when a stock will hit a new high — or low.
It’s better to invest in an index representing the entire market than to pin your hopes on one company.
4) The Gambler’s Fallacy. Again, this is short-sighted behavior based on what you believe is a trend. Let’s say a stock’s price has risen in the last three quarters. Does that mean it will rise in the fourth quarter? Not necessarily.
Stock prices move in random directions and are hard to predict. There are no such things as streaks when you apply the laws of probability. Don’t believe that you — or any money manager — has a hot hand. It’s often just due to luck. Stay put if you have winners. Don’t pretend to know the future.
The best way to short-circuit all of this money-losing behavior. Figure out the percentage of stocks and bonds you want to hold long term that will help you beat inflation and save enough for retirement. For most people, 60% in stocks and 40% in bonds is a good middle road. If you can sleep at night with that mix, you needn’t make any more decisions and your stomach will be a lot calmer.
This article was written by John Wasik from Forbes. This reprint is supplied by BNY Mellon under license from NewsCred, Inc.
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