Investing Behavior

“Sometimes investors can be their own worst enemy.”

When it comes to investing, we have met the enemy, and it’s us, according to Forbes. Excited by profit and terrified of loss, investors let their emotions and minds trick them into making terrible investing decisions. “As humans, we’re wired to act opposite to our interests,” says Sunit Bhalla, a certified financial planner. “We should be selling high and buying low, but our mind is telling us to buy when things are high and sell when they’re going down. It’s the classic fear-versus- greed fight we have in our brains.”

Understandably, successful investing is challenging, but it doesn’t require genius or years of deliberate study. However, it does require rare investing qualities of faith, self-discipline, patience, and the ability to identify and overcome one’s own psychological and behaviorial weaknesses. Charlie Munger, Vice Chairman, Berkshire-Hathaway, said it best, “You don’t make money when you buy and you don’t make money when you sell. You make money when you wait.” In short, every investor wants to invest well, but the reality is that most investors vastly under perform the market, according to a 2021 Dalbar study of investor behavior.

The study found that individual fund investors consistently underperformed the market over the 20 years ending December 31, 2020, generating a 5.96% average annualized return compared with 7.43% for the S&P 500 and 8.29% for the Global Equity Index 100. The DALBAR Ratio, referred to as the “Behavior Gap”, demonstrates that what investors actually earns from their investments is not the officially listed returns on a financial fund prospectus.

“Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” Warren Buffett

When the market is melting up, investors are more eager to jump into the frenzy and participate. When the market is melting down, investors are more eager to flee to the exits and sit it out on the sidelines. Generally, this causes investors to “buy high, sell low” their stocks, ETF and mutual funds.

Despite the many challenges, there are several important takeaways for investors to better understand why they tend to make financial decisions that are contrary to their own best interests and continue to get them into trouble, such as:

Checking Portfolios Too Often – The problem is that people are generally loss-averse. They experience negative feelings from a loss that are stronger than the positive feelings they get from a gain. Measuring performance on a daily basis seems certain to drive the risk premium even higher, costing investors considerably return.
Trading Too Often – Over-trading is what gets most investors in trouble. When markets get drops, investors tend to bail out of the market. “It’s only natural–literally, our brains are wired this way. “Trading is hazardous to your wealth.”
Getting Distracted by Shiny Objects – Invesors are bombarded with stock ideas and some decide that the latest hot stock is a better idea than a stock they own, and they make a trade. Unfortunately, the stock comes to the public’s attention because of its strong previous performance. When this is followed by a reversion to the mean, new investors get burned.

In a nutshell, it is somewhat obvious that investor’s behavior is the biggest factor that drives long-term success. Yet, investors do hold the keys to their own long-term success through regular, consistent, disciplined investing.

Many individual investors hurt themselves by making too many trades for too many dubious reasons. You can be a much better investor when you learn to research and select stocks carefully, to be patient and wait, and to learn to block out the incessant financial news media noise. The takeaway should be that behavior is clearly the single most important variable in the long-term performance results of investor and that you should focus on how not to be your own worst enemy.

References:

From Gratitude to Greatness: Brownlee Global's Path to a Purposeful Life

Guide and Educate Individuals How to Build Long-Term Wealth, Better Manage Their Money, and Achieve Financial Freedom

Like this:

Related