Avoiding Common Investment Mistakes
Last week’s invasion of Ukraine, stubborn inflation, and concerns about interest rates have all contributed to a rough start to 2022 for investors. In trying to make sense of the markets, you may find it easy to succumb to emotional biases and kneejerk reactions based on news headlines. But before you take action, take a deep breath and read on to avoid making some of the most common investment mistakes.
#1 Taking Action for the Sake of Taking Action
When the markets turn volatile, it may feel natural to want to take action, but we believe the best reaction to a market event may be to take NO action at all. For example, imagine yourself on a rollercoaster ride with many sharp twists and turns. While you may not enjoy the ride, you would likely never consider unbuckling your seatbelt and trying to exit your assigned car – doing so wouldn’t be safe, so you stay in your seat and ride to the end of the line. Applying that same discipline in investing may prevent you from making a mistake during a period of increased volatility. Historically, U.S. equity returns have been positive following sudden market downturns. Staying in your seat may help position you to capture the recovery.
#2 Trying to Time the Market
Reacting to a crisis by leaving the market or taking a different action is just a form of market timing – trying to predict when the market will have a positive or negative return. When trying to time the market, investors have to make two correct decisions: when to get out, and when to get back in. Often, investors are unable to determine the perfect time to sell or buy, and a decision to reinvest may come after a rebound has already begun, resulting in a missed opportunity. Moving in and out of the market can also lead to increased costs and potential tax implications.
As an investor, you are better off focusing on your long-term goals and contributing to your portfolio rather than attempting in vain to time the market.
#3 Chasing Past Performance
You’ve likely read this phrase in an investment brochure: “Past performance is no guarantee of future results.” That’s because past performance offers little insight into a fund’s future returns. Analysis conducted at Yale determined that a fund’s performance in the past year does not help predict how it will perform in the future – in fact, it’s completely unpredictable. So, choosing to invest in a fund based on its past performance could actually hurt your portfolio instead of helping it.
#4 Failing to Manage Your Emotions
Last year, a group of retail traders – using Reddit to communicate their strategy – sent the stock of video-game seller GameStop through the roof. In a rush of excitement, other investors followed suit, driving the stock price to $347.51 per share on January 27, 2021. (It closed Feb. 25 at just over $118 per share.) While some investors got lucky, others – including short sellers – lost significantly. Emotional investing can be very risky and may not align with your long-term goals. Reacting to the headlines is an example of recency bias, the most widely observed investor bias in the 2021 BeFi Barometer survey. Recency bias, which advisors observed 58% of the time, involves being influenced by recent news events or experiences.
#5 Putting All Your Eggs in One Basket
Diversification is key when it comes to investing. While it may be tempting to focus your investments in U.S. stocks, particularly following a period of relatively strong performance, doing so could keep you from achieving your investment goals. First, country returns are unpredictable. For example, among 44 developed and emerging market countries since 1999, the U.S. market has never been the top performer, according to Dimensional Fund Advisors. In addition, nearly half of the global opportunity set in stocks lies outside the U.S., so failing to invest globally restricts an investor’s ability to capture higher expected returns. Diversifying your portfolio can help balance risk and weather market volatility.
Working with a Financial Advisor Can Help
We believe one way to help increase your odds of avoiding investment mistakes is to work with a competent, ethical financial advisor who will place your interests first. Your financial advisor can help you design an investment strategy that will help you move closer to achieving your goals and work with you to ensure you’re still on track – even during market volatility. Your advisor can also act as your accountability partner, helping you make sound decisions and avoid behavioral biases that often plague even the most sophisticated investors.
At Savant, we take an evidence-based approach to investing, which uses data, research, and our collective knowledge of risk and return to help maximize the likelihood that clients will achieve their desired outcomes. If you’d like a second opinion on your portfolio, we invite you to schedule an introductory call with a member of our advisory team.