Cents & Sensibility — Avoid common investment traps

Beth Peabody

The action item for August listed in this column urged readers to use their time, talent and treasure to become happier and more optimistic about the future.

Continue to focus on the good financial decisions you have made. Reframe negative thoughts stirred by scary headlines like current ones focusing on inflation and just a few poor days of recent financial market performance.

Instead of stressing, avoid getting caught in the following common investor psychological traps.

  • Hindsight is not foresight: Avoid becoming overconfident. An investment strategy that has worked in the past does not mean that it will be successful in the future. Focus instead on remaining diversified in your approach to investing. Do not place all your eggs in one basket, such as investing only in a few securities, especially if this includes your employer’s stock. If the company does poorly, stock market performance will weigh on your savings at the same time you might be impacted by the company laying off employees.
  • You are smarter than the rest: Unless you devote multiple decades of your career and free time to studying the investment industry, you cannot compete with the knowledge held by professionals. Having insight that is greater than those who are actively involved in the investment industry is not possible. Let the experts manage your money and focus your effort on improving skills to assist with career advancement.
  • “I can buy high and sell low”: Investors trying to make these decisions have to be right twice by timing getting in and getting out. Perfect “market timing” is virtually impossible. If the experts on CNBC and other news outlets were so smart, one wonders why they have yet to retire. Many studies prove that the investment returns earned by individuals over a 20-year period ending 2021 were significantly lower than those who remained invested for the entire period.
    For example, an investment in the S&P 500 index (a popular gauge of U.S. stock performance) would have generated an annualized return of 9.5%. A portfolio allocated 60% to this index and 40% to a benchmark U.S. bond index would have compounded at a rate of almost 7% per year. Meanwhile, the average investor earned half of this return at only 3.6%. Stay invested and do not jump in and out of financial markets.
  • Desire to make a quick buck: This is one of the biggest mistakes as individuals generally chase past returns. For example, the meme stock craze which featured dazzling returns from stocks like GameStop. Using this stock as an example, at year-end 2020, this stock traded for $5 per share. Three weeks later it soared to $81, then two weeks later it was back down to $10. Add two more weeks of performance and it soared again and hit $66 and one month later it was back down to $39.
    Another “get rich” theme has included cryptocurrencies. Using Bitcoin as an example, it traded at approximately $23,000 in December 2020. One month later it soared to $56,000 only to drop below $30,000 within five months. It currently trades at approximately $20,000. Both of these examples serve as proof that making short-term investment decisions by timing when to get in and, better yet, when to get out of positions is extremely difficult.
  • Emotional attachment: Keeping an investment because it was gifted to you by a parent or grandparent is also a potential trap. Decisions should be based upon the opportunity it provides, not based upon sentiment. Another emotional trap is not to acknowledge that an investment was a mistake.
    Do not use “let’s wait until the price comes back up” as an investment strategy. This rarely works, and if the price does move back to the expected level, individuals often use this improvement as a reason to continue to hold it because “it’s doing so well.” Emotions should not lead your investment decisions.

Action item for September: Examine your own investment behavior to see if you may have fallen into any of the psychological traps outlined above. If you have, take steps to correct the behavior.

Beth Stegner Peabody, CEO of Stegner Investment Associates, is a graduate of St. Agnes School and Sacred Heart Academy.

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