While humans are creatures of great intelligence, when it comes to investing, we repeatedly make dumb decisions. And most of the time, investors are their own worst enemy. You see, it’s not just the performance of the funds in your portfolio that drive success. Investing success is also a function of the decisions you make along the way; in essence, bad investor behavior can have an even greater impact on your portfolio’s performance than the market itself.
Aside from what traditional theories like to assume, investors do not always act rationally. In the reality, they are quite vulnerable to irrational behavior. This is because money is emotional, and emotions can overtake even the best laid plans. Unfortunately, impulsive or “feel good” financial actions don’t always support positive long-term growth. They tend to support poor decisions that can leave investors worse off than when they started.
6 Bad Investing Behaviors to Avoid
We can’t discuss irrational investor behavior without understanding the actions that drive investors there. After all, it’s the psychological traps and misconceptions that ultimately trigger bad behavior. Bad behavior then leads to buying and selling at the wrong time, which can prevent investors from reaching their full financial potential.
Almost every investor is familiar with the general rulebook for building wealth. The problem is that many investors are often blind to their own bad habits. In order to overcome them, investors first have to be able to see them.
Here are six investor behaviors that are important to recognize and avoid:
1. Loss aversion. This theory reveals that loss is felt much more deeply than the gratification that comes with gaining. In other words, losing $5,000 will always hurt more than gaining $10,000. This mindset can cause several poor decisions to take place however, including holding onto losing funds for too long in order to avoid realizing a loss. On the other hand, it can drive investors stock pick, only investing in funds they believe will produce the largest returns.
2. Overconfidence. It’s human nature to think that you are superior to others around you. So naturally, investors think that they have the skills and knowledge to consistently beat the market. What usually happens is that investors find themselves continuously trading stocks they believe will outperform with little to show for it – aside from steep portfolio costs. Don’t be fooled by Wall Street’s appeal to our inherent above average mindset.
3. Just going with it. While many investors have financial goals in mind, a shocking percentage of them have no plan to actually achieve them. Investors who wing it and have no clear understanding of the “why” behind their investments will be hard pressed to develop a disciplined approach that results in success. And a disciplined plan is paramount. Remember, a goal without a plan is simply a wish.
4. Chasing the winners. Investors routinely tend to take an all or nothing approach. For example, say you’re holding 50% bonds and 50% stocks. Depending who’s winning at the end of the year may leave you feeling inclined to dump the loser altogether because you want to yield positive returns. But chasing the winner isn’t always a formula for success; when you dump the losers, you dump the possibility for gaining tomorrow’s winners.
5. Information overload. Believe it or not, there is such a thing as too much information. Our media outlets are saturated with financial talking heads all claiming to have the answers to investing success. But investors routinely seek out information that confirms their own biases and beliefs. When you listen to someone who is simply telling you what you want to hear, that information can have a greater likelihood of hurting rather than helping you.
6. Market timing. Wading back and forth between trading and investing can be detrimental to your success. Investing is simple: You’re gradually building wealth over a lifetime. Investors have a hard time with this, and engage in trading for instant gratification. They become obsessed with the high. But many will find themselves chasing it more than experiencing it, as it’s been proven time and again that investors are horrible at timing the market.
Why Does it Matter to You?
Reaching your full financial potential depends on more than where you put your money. You have to recognize the role that good habits play in your journey. And the importance of avoiding the bad habits that can deter your success. Understanding this is crucial, and until you do, you can’t form a disciplined investment philosophy based on your most important goals.