Investing success relies more on patience and discipline than return on investment. It can also require pain and sacrifice. Yet, many focus so intently on potential returns and trying to predict the future. Instead, focus on what you can control. The biggest risk to investing success is bad investor behavior, not the investment.
If you are suffering from any of the following feelings about your investments, there is hope. If left untreated, these feelings can lead to poor results, falling short of goals, and a lackluster retirement.
Investor Behavior: Are You Suffering From These?
Overconfidence: A recent string of investments that have performed well can lead to overconfidence when it comes to investment selection. This can cause one to focus on the potential upside of investments while de-emphasizing the potential downside. Overconfidence is very similar to the “hot hand fallacy” in basketball. Assume a player is on a hot streak and has made the last five shots in a row. You assume the player will make the next shot. It might also cause the player to make an ill advised shot.
Assume that you picked some stocks that subsequently rose during the last several months. Your perceived success in picking stocks may be less attributable to you and more attributable to other factors. Was it really your wisdom that led to the results or was is due to a rising market or simply luck? This is where so many investors go wrong and it's an excellent reminder of investor behavior to be avoided.
Many investors become overconfident and assume a sell off in stocks due the Dow Jones Industrial Index crossing the 20,000 mark. The fact that stocks are at all-time highs doesn’t mean a downturn is right around the corner. Regardless of the current level of the stock market, one should always assume that a downturn is possible. Rather than assuming a stock sell off is near just because markets have risen, just assume there could be a pullback at any time.
Hindsight Bias: There is an old expression that hindsight is always 20/20. According to Morningstar, the definition of hindsight bias is “believing that unpredictable past events, in retrospect, were obvious and predictable.” This can lead to feelings of regret and frustration and negatively effect future decisions.
The mortgage meltdown and subsequent financial crisis of the last decade can be used as an example of hindsight bias. There were a small number of people who saw these events coming and connected the dots. The Big Short by Michael Lewis goes into great detail about what led to the crisis and told the story of those who saw it coming.
But it wasn't until after the crisis that everything became so clear. As we look back on what was happening in the real estate market and mortgage lending during that time, it is obvious how dangerous the effects would be on our financial system. But that is with the benefit of hindsight.
As the effects of the crisis eventually subsided, the fear remained. Many were convinced that financial markets would never recover and felt like another crash was right around the corner. They were wrong there too.
Short-Term Focus: If you focus too much on near term events, you risk making short term decisions that can negatively impact your long term results. The reality is that what happens tomorrow, next week, or next month will most likely have little impact on the long term results of an investment. Unless of course you react to it.
This is why many financial planners and investment advisors suggest a disciplined long term investment plan rather than trying to time the market. If you want to be a trader, that’s fine. I'm not suggesting that they are bad or doing it wrong. But trading is different than investing. This is especially the case if you are investing for the long term. Let your risk tolerance, investment objective, and time horizon be your guide and learn how to tune out the noise.
If you have a long term investment plan and you decide to wait for a pullback in the short term, you might find that the market has run up another 5%. What do you do then? Do you wait even longer for a pull back? Remember, at the beginning of 2016 when the Dow was down roughly 10% at around 15,800, there were plenty of reasons to suggest the market would continue to drop. Sentiment can change and change fast.
Investor Behavior and Investing Success
If you're an investor and experience these feelings, there is hope. The sooner you can control these feelings and behaviors, the sooner you can be in control. Most of the things that affect our investments are outside of our control. What you can control is your behavior and how you react. If you focus on what you can control, you are on your way to investing success.