When it comes to investing, too many of us think in terms of buying individual stocks. We tend to get nervous and worry about making the “right” move.
It’s also common for us to get caught up in the emotions of the moment. Excited that the market is gaining? We feel like buying. Is the market tanking? It’s tempting to jump on the bandwagon and sell.
However, making decisions based on the market can get us in trouble, according to Dan Egan, the Director of Behavioral Finance and Investing for Betterment.
Getting caught up in emotion and abandoning an investment plan because of market movements can be detrimental to your long-term financial health.
Emotion isn’t all bad
First of all, says Egan, emotions aren’t all bad when it comes to money and investing. “Emotion, at the base, is a good thing,” Egan says. “What motivates people to start saving and investing is fear for the future. They want to think ahead and secure their finances.”
The kind of emotion that kicks your investment plan into gear is a positive thing. Unfortunately, once you start investing, emotion can get in the way and cause problems. Sometimes the emotions we feel have no place in long-term investment planning.
Egan says there some things investors need to be aware of in order to avoid some of the pitfalls associated with the stock market.
Concerns about the short-term
One of the biggest pitfalls to watch out for includes getting caught up in the short-term. “Even though we, as humans, have the ability to think about the future, we are biased toward the short-term,” Egan says. “People value $100 today more than they value $120 on Friday.”
Egan points out that even though Friday isn’t that far into the future, people are more likely to value what they have today, and it impacts how much we are likely to save – and the risks we are willing to take.
He also says that our tendency to focus on the short-term can hurt us when we look at fluctuations in the stock market. We pay more attention to the big swings we see in the headlines. However, if you look at a trendline for the market, things smooth out over time.
But it’s hard to focus on that long-term trendline when the headlines are screaming at you today. “Even when you have a long-term investment plan, we don’t like the short-term fluctuations in the market, and it’s easy to get caught up in the emotion of these fluctuations,” Egan says.
Impatient for results
Another problem is that so many investors are impatient for results. “People don’t realize how important it is to stay in it for the long haul,” Egan says. “They see a slow start. They are impatient for big results and forget it’s a long-term game.”
This is especially true when you use dollar-cost averaging. Dollar-cost averaging using index funds or ETFs is a solid strategy for beginners who don’t have a lot of capital to begin with. You can put a small amount of money in each month and let it grow. With dollar-cost averaging, consistency over a long period of time eventually yields results.
“Compound returns are huge, and many of us discount them because we are impatient for results today,” says Egan. “The impact of these returns is huge, but it’s hidden, so you won’t see it for 30 years.”
But that’s just in time to retire. You’ll be glad you stuck to your investment plan when you can retire in comfort.
3 ways to beat emotion when you invest
If you want to be successful in the long term, it’s important to keep your emotions in check. Warren Buffett advises us to buy when others are fearful, and sell when others are greedy. That’s one way to help us decide when it’s time to buy or sell. (Or, if you are using dollar-cost averaging with index funds, you can just keep plugging away as planned.)
The key, according to Egan, is to avoid making decisions just because the market is doing something.
Not too long ago, he says, he and his wife decided to move up the timetable for buying a home. Because he knew he would want his money sooner than expected, Egan shifted his asset allocation to be less risky. “I changed things, but not because of anything going on in the market. I did it because it made sense with my own goals and financial situation.”
Here are some of the ways Egan suggests you keep your emotions under control so you can stick to your investment plan:
1. Use technology to your advantage
“We have a great advantage with technology today,” Egan points out. “We have the ability to invest automatically, rebalance automatically, and advisors that can keep us on track.”
As someone who works for a robo-advisor, Egan sees firsthand how useful it can be to automate some of the aspects of investing, especially when it comes to investing for long-term goals like retirement.
Dollar-cost averaging works especially well with robo-advisors like Betterment. You can designate a set amount to invest automatically each month, and the algorithm takes care of the rest.
2. Pay attention to the TV
Egan doesn’t want you to watch financial news to get really good ideas. Instead, he thinks it’s a valuable exercise to watch for a period of time so you learn to ignore what’s going on.
“If you really pay attention,” Egan says, “you learn how much random noise there is in the market.”
“Just watch,” he continues. “Don’t act on it. Pick a stock and watch how it goes up and down for no apparent reason. Get emotionally comfortable with ignoring the stuff that’s going on so that you feel better about knowing you don’t have to do anything.”
Once you really see how much noise it is, you’ll be less likely to get worked up by headlines.
3. Turn off the TV
Ideally, though, Egan says you’ll turn off the TV and just avoid the noise altogether. When you have an investment plan, you don’t need to worry so much about how many points the Dow dropped today. You also don’t need to fret about whether or not the huge bull market you see is a bubble.
Instead, Egan recommends coming up with a system. You can decide to buy at a certain point, and sell at a certain point. For most people, though, the long-term system is pretty simple. Use dollar-cost averaging to buy on a set day of the month, and sell later on, when you need to rebalance or as you approach retirement.
Stick to your investment plan
In the end, your best bet is to identify your long-term goals, and figure out how much you should invest each month to help you reach those goals. For most people, it makes sense to set something up that doesn’t need a lot of tinkering.
“Your long-term portfolio is a lot like a bonsai tree,” says Egan. “People feel like they should be monitoring all the time and messing with it. However, the more you mess with a bonsai tree, the more likely it is you will hurt it, not make it better. The same goes for your portfolio. If you check it too often and think you need to tinker, you could end up losing more than you gain.”
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