To err is human. Research in behavioral economics has shown that investors are just like other people—well-intentioned but fallible. Even experienced investors can make costly mistakes with their money.
Here are four everyday behaviors that can lead to a financial faux pas—and how to avoid them.
- Buying based on limited information. Choosing to invest based on incomplete information can negatively affect your portfolio. Say you hear about a company on your favorite financial podcast. Over the next few months, their name keeps popping up on the same program—always in a positive context. You ultimately pull the trigger to invest and the decision seems informed. But by only listening to a single source, have you really done the requisite research?
Economists call this bounded rationality—making “rational” decisions based on limited information, not realizing that what you think you know may be incomplete or biased. One of the best ways to avoid this pitfall is to proactively expand the resources that you turn to when researching an investment. Seek out alternative takes on the company, especially from sources you don’t typically read or listen to. After that, talk to investment experts you trust to get a broader picture of the sector or industry that’s piqued your interest before taking the plunge.
You’ll never have perfect information, but if you kick the tires and do your homework, you’re far more likely to make an informed decision. (If this sounds like a lot of work, it is—and there’s also the danger of information overload. We see this conundrum as one of the greatest values we as wealth managers bring our clients—we do the research and closely track your portfolio to make sure that yesterday’s decision is still a good one today.)
2. Falling prey to FOMO. As financier J.P. Morgan once said, “Nothing so undermines your financial judgment as the sight of your neighbor getting rich.” Seeing other people strike it rich in the latest fad investment—think, bitcoin, SPACs or meme stocks—can cause even the most disciplined investor to feel like they are missing out. But positive short-term performance is seldom a guarantee of lasting profitable results. We call the belief that today’s good times will extend into tomorrow “recency bias.”
The best way to avoid following the fast crowd over a cliff is to maintain your diversification discipline. A well-diversified portfolio reduces your risk when the flavor of the moment experiences an inevitable correction.
3. Beating a hasty exit based on fear. Investors can get spooked and sell out of the market for fear that a correction is coming. Alternatively, when an investment does particularly well, people may exit early in fear of a sell-off. But hasty exits can have tax ramifications, not to mention the loss of future gains.
Corrections in individual stocks, funds or entire markets are inevitable and no one can predict exactly when they’ll occur. We believe that spending time in the market—rather than trying to time the market—is the smarter, more profitable path to meeting your investment objectives. A solid way to avoid hasty exits is to set rules for yourself. Choose a target price or a time frame that’s tied to your financial goals. When it comes to returns, discipline trumps fear.
4. Getting cocky. Investor overconfidence becomes contagious when a bull market runs long. It can cause investors to take risks in their portfolios that they would otherwise avoid. The best remedy is to engage with your financial adviser, candidly discuss your risk tolerance, and create a comprehensive financial plan that will meet your needs over the long term. Be disciplined and stick with it.
As always, your situation and outlook are unique. We encourage you to speak with your wealth management team here at Adviser Investments whenever you have questions about your investments or your financial plan. We’re The Planner You Can Talk To and we’re here for you.
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