Beating the market sounds like a noble goal. Simply get in at the right time and out at the right time – and get rich. But human emotions usually make such a feat impossible.
The allure of beating the market draws in many people. They end up on an emotional roller coaster of financial decision-making. A big surge in the market occurs, perhaps a bit of adrenaline and greed sets in, and you buy. Then the market dives, fear takes over and they rush to sell. This is a great way to go broke. Allowing emotions and investing to mix is a dangerous game and it often results in poor financial decisions.
Of the many variables that can influence portfolio performance, investor behavior is probably the most important.
Emotions can lead investors to take the wrong action at the wrong time. It is easy to stay disciplined and adhere to your financial plan when the markets are doing well, but remaining on course is much tougher when the markets are volatile.
Most people are familiar with the investment adage, “buy low and sell high.” This is a simple enough concept, but when human emotions get involved, simplicity often goes out the window. Knowing the precise time to buy and sell a stock is a rare skill. Most people end up executing trades at the wrong time and instead buy high out of greed and sell low out of fear.
Don’t overlook the role of emotion in the success or failure of an investment strategy. How do you put aside emotional urges and stay on track financially? Investors are highly unlikely to beat the market, and further that market timing usually results in lower returns than those generated from a buy, hold and rebalance strategy. In the 10 years that ended in 2012, the average investor made a 6.1% return, lagging behind the average mutual fund, which returned 7.05%. In fact it is so hard to beat the market that even supposedly genius hedge fund managers often fail to do so.
Also, even if you make good decisions, the more frequently you buy and sell, the more fees you pay. The higher fees diminish your investment returns even further.
The constant flow of information actually causes more harm than good for the average investor, by creating an environment where investors are inclined to buy and sell based on pure emotion.
In the 2006 study, “All That Glitters,” business professors Brad Barber and Terrance Odean found that individual investors buy stocks that grab their attention, much to their own detriment. These, they wrote, are “stocks in the news, stocks experiencing high abnormal trading volume and stocks with extreme one-day returns.” Because investors are so overwhelmed with the thousands of stocks available, many purchase only the stocks companies that stand out, whether they should or not.
The study found that the attention-driven buying patterns “do not generate superior returns.” In fact, the professors concluded that most investors can do better by just buying and holding a well-diversified portfolio.
So how can you tune out the volatility and enrich yourself, rather than your brokerage? Connecting with a financial advisor who can help you establish a long-term approach might help you maintain perspective and discipline over the long run. An advisor can help you to set clear, appropriate investment goals, develop a well-diversified portfolio and minimize the overall investment cost.
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