Investing is the act of committing your money to a financial market with the expectation of making a profit. While nobody invests with the expectation of making a loss, losses happen. Since investing involves risk-taking, a negative result is always possible. Some losses are caused by the investor rather than by the investment. Investor psychology and behavior are important factors which contribute to losses. Here are five behaviors which can bring bad results:
1. Acting on impulse – not information. Impulsive investment behavior is rooted in intuition or a hoped-for lucky hunch. How do you measure a hunch or intuition? How do you duplicate the result? A good outcome based on luck may create a false understanding of how the gain occurred. A bad outcome can create negative reinforcement toward the investing process. Successful investing relies on the use of logic and reason which develop from information. Impulse lacks logic and reason.
2. Buying high, selling low. Why do some people get caught in a cycle of buying at market highs and selling at market lows? Watching the news will give you a clue. Both good and bad news about market performance will create a reaction in people who want to be part of the group that has participated in profits or has avoided losses. A person influenced by the need for group inclusion may act at the wrong time. The forces of peer pressure and the desire to be part of the “in” group are poor motives for making investing decisions.
3. Trading rather than investing. Trading is buying and selling on a short-term basis, hoping to make quick profits. Unfortunately you can also make quick losses. Trading is a speculative strategy that involves a higher degree of risk and takes place over a short time period. Generally, people who speculate tend to have a greater percentage of losses than gains.
4. Failing to offset risk. Investors can offset risk by their choice of investment, frequency of investing and strategies that reduce risk. Some useful strategies for reducing risk include using research to assess the quality of investment choices, choosing conservative rather than aggressive stocks, purchasing stocks periodically rather than making a single large purchase, and diversification.
5. Reacting to fear and greed. It has been said that the two forces that drive the stock market are fear and greed. This pessimistic view about human nature is not necessarily true for the prudent investor. Using “reasonable” as a standard in determining a satisfactory investment result helps blunt the effects of human emotion. A long-term plan that takes market fluctuation into account will reduce anxiety caused by market declines.
A well-reasoned long-term investment strategy, coupled with knowledge and understanding about the nature of investment securities, can help investors avoid costly behavior.
Howard Feigenbaum is Registered Principal and Owner of Sharemaster, a Broker-Dealer firm that specializes in monthly dividend income funds.
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” – John D. Rockefeller
This article is a general discussion of the subject and is not intended as a solicitation or specific investment advice.
Copyright 2011 Sharemaster
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