A good reading from IBD:
By Investor's Business Daily First of two parts Don't Let Irrational Fears Psych You Out To Maximize Returns, You Must First Master Your Emotions
Date: 3/27/98
Author: Adam Shell
Managing money makes some investors nutty. The opposing forces of greed and fear have a way of transforming rational people into emotional basket cases. Often, investors make impulsive buy and sell decisions that are anything but rational.
Indeed, when it comes to investing, irrational behavior is the norm, not the exception, say experts in the burgeoning field of behavioral finance.
Investors think they're smarter than they really are. They react wildly to bad news, often selling shares of perfectly good mutual funds. And they feel the pain of losses more acutely than they do the joy of paper profits.
That's too bad. Why? People's emotions often interfere with their ability to make money investing in funds.
Here are some of the mental miscues investors make that crimp their returns - and tips on how to avoid them.
Fear of losing money. Investors tend to exaggerate their losses. Often, they inflict psychic pain on themselves by doubling or even tripling their losses in their own minds.
''Psychologically, people give greater weight to a past loss than they do a future gain,'' said Kathleen Gurney, CEO of Financial Psychology Corp. in Incline Village, Nev.
In fact, some folks find losing money so distasteful that they psych themselves out of investing altogether.
One of Gurney's clients, for example, lost $40,000 in the market a few years ago and hasn't invested since. Yet small losses can be just as painful. In November, a West Coast investment club made up of a dozen well-to-do women chipped in $100 apiece to buy a stock, only to watch it plunge more than 30%. The club members haven't bought any stocks since, Gurney says, despite losing only $30 each.
''Investors don't make reasonable trade-offs,'' Gurney said. ''The drive to avoid loss really sabotages any future gains or opportunities.''
Solution: Determine ahead of time exactly how much you can ''emotionally'' afford to lose.
Regret syndrome. People hate to make mistakes. One bad investment decision is often all it takes to erode an investor's confidence, especially if their friends or co- workers sidestepped the loss. To avoid feeling like a loser in the future, an investor who erred often follows the herd and buys what everybody else is buying.
''Shame is a powerful motivator,'' Gurney said. ''The fear of regret paralyzes investors.''
Solution: Face up to the loss. Don't let a bruised ego keep you from taking control of your finances.
Focusing on short-term results. Do you suffer from ''myopic loss aversion''? If you lack patience, check your account balance daily or grade your fund based on a single quarter, the answer is probably ''yes.'' So says Shlomo Benartzi, a UCLA professor who specializes in investor psychology.
''Too many people focus on short-term results,'' Benartzi said. ''Unfortunately, once you focus on short-term losses, the only thing that might look safe is money markets - definitely not the stock market. But stocks are what you need to own if you want to reach your long-term goals.''
Solution: Stop tracking your fund's NAV daily.
Worrying about the wrong risks. Investors are held captive by unpredictable yet frightening events like the '87 crash that they fear will leave them penniless. ''People are traumatized by dramatic events,'' Gurney said. ''They can't tolerate the anxiety.''
Investors put on ''blinders and ear muffs'' and tune out everyone, including their brokers. They exaggerate current crises. What's worse, they forget distant lessons. They overlook the fact that people who stayed fully invested during the '87 crash recouped their losses.
Solution: Don't base investment decisions on events you can't control.
Succumbing to peer pressure. Even though most hot tips don't pan out, many investors treat advice from friends and acquaintances as gospel. Often what appears to be reliable information is anything but. Said Gurney, ''We just love to trust our peers for some reason.'' Too bad they're often wrong.
Solution: Do your own homework, map out a plan and stick to it.
(C) Copyright 1998 Investors Business Daily, Inc. |
