The Psychology of Investing
http://www.pcwomensjournal.com/articles/109/1/The-Psychology-of-Investing/Page1.html
David Damm
David Damm, AIFCarolina Wealth
1706-A East Arlington Blvd.
Greenville, NC 27858
252-439-1344
www.carolinawealth.com
By David Damm
Published on 10/5/2009
One of my favorite quotes concerning investor behavior comes from the original guru of value investing, Benjamin Graham. His quote; “The investor’s chief problem and even worst enemy is likely to be himself.”
One of my favorite quotes concerning investor behavior comes from the original guru of value investing, Benjamin Graham. His quote; “The investor’s chief problem and even worst enemy is likely to be himself.” In my opinion, this quote points to one the biggest reasons why individual investors fail to outperform the markets in the long run. In fact, a study done by Dalbar, Inc. found that from the period of 1987 to 2007 the average investor underperformed the market index (S&P 500) by an average 7.3% per year! Why such a large difference?
Investor Behavior Causes Poor Market Returns
Several studies about investor behavior show that when the stock market goes up, people pour money into equity mutual funds, and when the market goes down, they pull money out. During bear markets, they pull even more money out. Therefore, they continuously chase trends (buy high and sell low) focusing on what is happening right now, not what will happen in the future.
Let’s face it, our emotions are our biggest enemy when it comes to successful investing. I keep a chart in my office called, “The Cycle of Market Emotions” which illustrates the pattern of behavior people tend to follow when monitoring their investments in the stock market. This destructive behavior is what I like to call, “the greed vs. fear battle”. When fear takes hold, it impinges our ability to make informed decisions. That is, we tend to want to re-evaluate our risk tolerance when the market is going down for “fear” of losing money. This behavior causes us to sell or change our investments at or near the market bottom. Conversely, when the markets are going higher, we want to start investing again so we do not miss the big rally. This “greedy” behavior generally backfires, as we will enter the market at or near the highs. Both irrational behaviors cause individual performance returns to be substantially less than index stock market returns.
Four Rules to Follow to Increase Your Market Returns
When it comes to your investments, if you feel your emotions are getting the best of you, come back to the following rules:
1. Do nothing - A conscious decision to do nothing is still a form of action.
2. Your money is like soap - To quote Gene Fama Jr., a famed economist, “Your money is like soap. The more you handle it, the less you’ll have.”
3. Never sell equities in a down market - If your funds are allocated correctly and you have a long-term investment objective, you should never have a need to sell equities during a down market cycle. Just as you wouldn’t run out and put a for sale sign on your home when the housing market turns south, don’t be rash to sell equities when the stock market goes through a bear cycle. Wait it out.
4. Science works - It’s been academically proven that a disciplined approach to investing delivers higher market returns. For example, my approach is to use proven money mangers, reduce fees, diversify investments and hold on for the long haul. What is your approach!
Start following these rules now and become one of the few investors earning above average market returns!
Investor Behavior Causes Poor Market Returns
Several studies about investor behavior show that when the stock market goes up, people pour money into equity mutual funds, and when the market goes down, they pull money out. During bear markets, they pull even more money out. Therefore, they continuously chase trends (buy high and sell low) focusing on what is happening right now, not what will happen in the future.
Let’s face it, our emotions are our biggest enemy when it comes to successful investing. I keep a chart in my office called, “The Cycle of Market Emotions” which illustrates the pattern of behavior people tend to follow when monitoring their investments in the stock market. This destructive behavior is what I like to call, “the greed vs. fear battle”. When fear takes hold, it impinges our ability to make informed decisions. That is, we tend to want to re-evaluate our risk tolerance when the market is going down for “fear” of losing money. This behavior causes us to sell or change our investments at or near the market bottom. Conversely, when the markets are going higher, we want to start investing again so we do not miss the big rally. This “greedy” behavior generally backfires, as we will enter the market at or near the highs. Both irrational behaviors cause individual performance returns to be substantially less than index stock market returns.
Four Rules to Follow to Increase Your Market Returns
When it comes to your investments, if you feel your emotions are getting the best of you, come back to the following rules:
1. Do nothing - A conscious decision to do nothing is still a form of action.
2. Your money is like soap - To quote Gene Fama Jr., a famed economist, “Your money is like soap. The more you handle it, the less you’ll have.”
3. Never sell equities in a down market - If your funds are allocated correctly and you have a long-term investment objective, you should never have a need to sell equities during a down market cycle. Just as you wouldn’t run out and put a for sale sign on your home when the housing market turns south, don’t be rash to sell equities when the stock market goes through a bear cycle. Wait it out.
4. Science works - It’s been academically proven that a disciplined approach to investing delivers higher market returns. For example, my approach is to use proven money mangers, reduce fees, diversify investments and hold on for the long haul. What is your approach!
Start following these rules now and become one of the few investors earning above average market returns!