Sabotaging returns
How investors sabotage their portfolios, and how to avoid it.
The stock market has raced to record highs this year, but your portfolio may not show it.
In some ways, that’s to be expected. You would have to be 100% invested in stocks to mirror the market’s performance, and that kind of aggressive allocation may not be appropriate for your risk tolerance or time horizon.
But generally speaking, if the market is having a good year, your portfolio should be, too. If it’s not, you may want to point a finger toward yourself.
Here are three behaviors that psychologists have identified that are most likely to drag down your returns, along with strategies to counteract them.
1 Overtrading
The vast majority of long-term investors shouldn’t trade frequently; those who do open themselves up not just to more risk but also to increased transaction fees and tax consequences, both of which can drag down returns.
If you tend to keep an enthusiastic finger on the buy or sell button, stay away from individual stocks. Instead, invest through index funds, which passively track a segment of the market.
According to Morningstar, the average dollar in passive funds typically outperforms the average dollar in actively managed funds.
2 Avoiding losses at all costs
“We hate loss more than twice as much as we like comparably sized gains. Win $50 at a casino and it’s kind of ‘meh’ but lose $50 out of your wallet and it ruins your night,” says Daniel Crosby, a behavioral finance expert and founder of the investment management firm Nocturne Capital. Because of that, we may hold on to poor investments longer than we should to put off recognizing a loss, or flee to cash at any sign of a downturn.
To temper a fear of loss, set a long-term strategy and then try dollar-cost averaging, which involves dribbling a set amount of money into your investments at regular intervals. If you contribute to a 401(k) or make scheduled transfers into an individual retirement account, you already do this.
3 Blinders hamper our decision making
If you read only political websites that align with your views or block Facebook friends with opposing politics, you already know what this means: It’s the tendency to discount information that discredits your established beliefs.
But your money will benefit from balanced research, both into future investments and the ones you already hold. When you rebalance your portfolio or re-evaluate your strategy, look at each investment as if you’re buying it for the first time, and dive into research from varied sources.