Now, more than ever, we are bombarded with headlines, market news, social media commentary and other “noise,” all of which can stir up anxiety about the future and tempt us to make investment decisions that may not be in our best interest.
Add to this the fact that we are hard wired with behavioral biases that can work to our detriment as long-term investors. Some psychological traps you can fall prey to include: holding a stock for too long hoping that the price will recover so it can be sold without regret (regret avoidance); overrating your own abilities, knowledge and skills relative to others (overconfidence); tending to invest in what you know, thereby creating a concentration of your wealth in one or a few familiar stocks or funds (familiarity bias); and a reluctance to make investment decisions for fear they will turn out badly (fear of regret).
With a constant barrage of media clamor combined with self-sabotaging behavioral tendencies, what’s an investor to do?
Create an investment plan to fit your needs and risk tolerance. A sound investment plan will address your specific needs and goals as well as your ability and willingness to take on risk. Longer-term goals, like educating your children, funding a comfortable retirement and building an estate for your heirs, require a longer-term investment plan—a plan that looks beyond short-term fluctuations and comparisons. When you invest with an eye toward longer-term goals, you do not need to “beat the market” or even avoid temporary downturns.
Accept that financial markets work. Market prices may be driven off track temporarily by misinformation, miscalculations, or psychological biases of investors. These imperfections may appear significant in the short term, but they become largely irrelevant in the long run. The lifetime investor is well advised to “tune out” factors that have short-term impact on the markets, and instead focus on the more consistent returns provided by the market over the long term.
Diversify broadly across asset classes and investment strategies. Allocating among a diverse group of asset classes is far more important than market timing or security selection in the determination of portfolio performance. And since we never know which market segments will outperform from year to year, holding a globally diversified portfolio helps investors to be well positioned to seek returns wherever they occur.
Review your plan and portfolio regularly. Your plan should be dynamic. Many factors that impact your portfolio design will change over time. Areas to monitor include your personal circumstances, opportunities and risks in the financial markets, performance of asset classes and fund managers. Your plan should be reviewed and your portfolio should be updated and rebalanced regularly, in a disciplined manner.
Stick with your plan. This is perhaps the most challenging step to follow. Far too many investors significantly underperform the markets over the long term, primarily because they buy and sell assets in response to emotions, rather than to execute on a financial plan.
Recognizing potential behavioral biases, looking beyond the headlines to our personal financial needs, and creating and sticking to an investment plan, will help us forge a more productive path to financial success.