Emotions often drive investors to make poor decisions and underperform.
Dynamic investing and overall fitness can often come down to discipline (and planning). Why aren’t you reaping the investment returns you read about in the financial press? Why aren’t you reaping the benefits of going to the gym? One possible answer that you might not want to think about is this: your emotions get in the way.
That’s what financial professionals (and personal trainers) are for – to help you stay the course and provide rational decisions.
Emotions Can Get in the Way
A research firm named Dalbar does tons of research on investor behavior. If you’re a fan of behavioral finance and economics, you should read some of Dalbar’s reports, but here is a summary: Emotions too often drive investors to make poor decisions.
According to Dalbar, investors consistently get returns worse than those of the market because they buy high and sell low. If you ever have a conversation with a friend about being scared after a downturn, you might fall into this category.
You are likely to underperform, even if you completely track the market with index mutual funds, because of yearly fees. They could be as low as 0.5% of your assets or as high as 2.5%. But if you have low-cost funds and you still do less than half as well as the market, the problem could be you, not the fees. You may have made poor choices, such as panicking during a slump.
It can be difficult to stay the course when the world seems to be falling apart. You might feel that, if you don’t get out when your investment drops, all of your money might disappear.
Recognizing Recency Bias
This brings us to another behavioral trap called recency bias. This fancy term means that we tend to pay a lot more attention to what happened in the recent past than what happened historically or what is likely to happen.
This is why, when the market goes down, you may think it’s going that way forever. When the market is hot, you might believe that there is only one way it can go – up.
If history is any guide, getting out when things look really bad is not necessarily a sound idea. An experienced investor might recognize that when the market seems at its worst, it could be a time to buy. Or perhaps to just keep investing, and let the market do what it’s going to do.
Research shows that staying the course is most likely to help you pursue your goals. If you’re looking to invest for five to 10 years or more, what happens this month, this quarter or even this year doesn’t make a big difference in your final outcome.
It all comes down to discipline and circles back to the role of financial professionals. A financial professional helps investors understand the history of the market and talk with them when they get over-excited or scared.
If you have great self-control, a financial professional might not be less necessary. But if you are not a disciplined investor, you might get some value from a professional who can talk you off the ledge. This is the role financial professionals play with their clients.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing in mutual funds involves risk, including possible loss of principal.
No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Past performance is no guarantee of future results.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by FMeX.
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