Investing shouldn't be difficult. Spend less than you earn.
Put the difference in a low-cost broad-based index fund. Leave it alone and let
it grow over time. Yet markets are unpredictable, and people are emotional.
Mixing the two breeds misbehavior and regret, as the temptation to buy stocks
when they're high and sell when they're low overwhelms common sense.
Successful investing is mostly a battle with your own brain.
With stocks more than doubling in value over the past five years, now is the
time to prepare yourself for the emotional roller coaster that will come during
the inevitable correction.
Here are three common pitfalls investors fall for.
Incorrectly
predicting your future emotions.
Too many investors are confident they will be greedy when
others are fearful. None assume they will be the fearful ones, even though
somebody has to be, by definition.
The vast majority of people overestimate their willingness
to take risk. Fear is a strong emotion and often plays a much greater role in
decision making than logic.
Past behavior may be the best way to judge risk tolerance.
If you panicked and sold stocks in 2008, you probably have a low risk
tolerance, regardless of what you think today. If you went headfirst into
technology stocks in 1999, you are probably susceptible to future bubbles,
regardless of how contrarian you think you are now.
Coming to terms with this reality is vital to avoiding
future regret.
Failing to realize
how common volatility is.
Napoleon was said to define a military genius as a man who
can do the average thing when all those around him are going crazy.
The same holds true for investors. You needn't have been a
genius to have done well in stocks over the past decade. You just had to not
have panicked in 2008, when everyone around you was going crazy.
One key to keeping a cool head during market drops is
realizing how common they are. If you don't understand how normal big market
moves really are, you are more likely to think a pullback is something unusual
that requires attention and action. It often doesn't.
Investors regularly want explanations for why the market is
dropping. The honest answer—that this is just what stocks do sometimes, like
why some days are colder than others—feels inadequate to some, which can cause
untold amounts of overanalysis, anxiety and misbehavior.
Trying to forecast
what stocks will do next.
The inability to forecast hasn't prevented the desire to
keep forecasting. No matter how bad forecasts are, investors come back for
more.
In 2005, investment bank Dresdner Kleinwort published a
study of aggregate professional forecasts such as stock prices, interest rates
and gross domestic product growth. As a group, the forecasts were terrible. But
the researchers found a fascinating trend: an almost perfect lag between
forecasts and actual results.
Analysts would wait until stock prices rose and then
forecast that stock prices were about to rise. After interest rates fell,
analysts would forecast that interest rates were due to fall.
A world without forecasts doesn't have to be scary. It just
requires making room for error. You have no control over what the market will
do next. You have complete control over how you react to whatever it does.
Click
hereto access the full article on The Wall Street Journal.