In investing, what feels natural can often steer us very much in the wrong direction. Follow your emotions and follow the crowd, and typically you’ll be led to perform the opposite of successful investing behavior. Rational logic should be the basis for any investing strategy, but emotions lead us to act very irrationally.
One way this plays out is in the common fallacy of thinking we can predict the future based on a slim slice of the recent past. Let’s say that you and your neighbor set out to drive to the same destination, ten city blocks away. You got there first. As a result, you conclude that the route you took is a better route, period. But any matter of things could have happened within those same ten blocks that affected your and your neighbor’s journeys today. You don’t yet have enough data to make a strong conclusion about whose route is better. If you both drove your respective routes every day for years and one of you consistently arrived first, then you might be better equipped to make a decision based on the data.
Investors are often led to make a similar and equally illogical leap. They look at the performance of an investment through the narrow lens of a short time frame and conclude that “it’s not doing well.” Then, they re-allocate their assets by selling out of this seemingly low performer and buying more of whatever investment is doing better. So the effect here is – you guessed it – selling low and buying high, which is the exact opposite of successful investing. Over the long term, this is a good way to start with a small fortune and wind up with a very tiny one.
So, what can an investor do to preempt the natural tendencies that lead people to make irrational investing decisions?
- First and foremost, create a balanced, diversified portfolio and commit to investing for the long term. That means investing in a balanced basket of stocks, bonds, and commodities, not picking and choosing single stocks or trying to time the markets.
- Set it, and forget it. Set a reminder for yourself to check your accounts on a schedule, and then tune out the market noise and media hype for the rest of the time. Monitoring the news and your accounts every day is not helping your stress levels or your long-term investment success.
- Work with your fiduciary financial advisor to create an Investment Policy Statement. This outlines your investing strategy in black and white, and helps hold you accountable to your own smart investing plan.
