Help Desk: How our behavior can hinder our investment returns

By Jason Policastro, as published in the Baltimore Business Journal

The eminently quotable Mike Tyson once said, “Everyone’s got a plan until they get punched in the face.” (In fact, he recently field tested this theory with an unruly fellow airline passenger.) This year, the market has been throwing vicious combinations at investors, including the war in Ukraine, a persistent global pandemic and rising interest rates. It’s enough to lead even the most seasoned investor into imprudent decisions that can endanger their investment goals.

Here are some common behavioral pitfalls that can disrupt even the most thorough financial plan.

The temptation of timing

When markets head south, our flight response kicks in and tells us to head for the exits. The problem is that after exiting, it’s nearly impossible to re-enter the stock market in time to avoid missing the biggest part of the rebound.

A recent study by JP Morgan Asset Management analyzed the performance of a $10,000 investment between January 2, 2001 and December 31, 2020. It revealed that seven of the best 10 days occurred within two weeks of the 10 worst days. Six of the seven best days occurred after the worst days. In 2020, the second-worst day was followed by the second-best day. The more positive days you miss, the more dramatic your loss will be.

Trying to time market fluctuations is like trying to thread a needle in a tornado: you’re not likely to succeed and you’re likely to get hurt. Your odds of success rise dramatically with the time spent in the market. In his book “The Psychology of Money”, Morgan Housel writes that the historical odds of making money in U.S. markets are 50/50 over one-day periods, 68% in one-year periods, 88% in 10-year periods, and 100% in 20-year periods (so far). The key is to stay in the game.

Trading on touchscreens

The rise of technology has put our finances at our fingertips. Smartphones and tablets enable us to access and trade in our investment accounts at a moment’s notice. According to a 2021 study, U.S. brokerage firms report that more than 20% of all trades by retail investors were executed using mobile devices, and many experts predict that this number will double in the coming years.

Now making a trade is as simple as checking Facebook – and just as habit-forming. That may explain the massive increase in trading over the past three years. In 2019, the purchases of exchange-traded funds were about $700 million per week. In 2021, that number had climbed to $2 billion.

What’s wrong with more convenient and frequent trading? The more you’re making trades, the lower your returns will be. Just look at the metric of investor returns versus asset returns. For the 20 years ending in 2019, the S&P 500 Index averaged 6.06% per year, while the average equity fund investor earned only 4.25%, according to a recent study by Dalbar, Inc. Investors who can keep their hands off their investments will enjoy stronger performance over time.

Forget the FOMO

We’ve all been there – your brother-in-law pulls you aside at a barbecue to brag about how much he made trading the latest meme stock or newly minted cryptocurrency. You’re left feeling like you’ve missed out, and your buy-and-hold strategy feels less like prudence and more like an outdated jalopy getting passed by a Tesla.

The reality is that for every successful trade on speculative assets, there are a thousand that cratered. We just don’t hear about them. It’s easy to fall into the trap of thinking “well if he can do it, so can I.” But you’re not getting the full story.

FOMO – or fear of missing out – is just the latest version of a timeless investor mistake: Chasing performance, which is making investment decisions based on the recent performance of an asset. Wayne Gretzky used to credit his success in hockey to skating where the puck was going, not where it had been. Your results will be far better if you’re sticking with an investment strategy that’s oriented toward the long-term instead of looking for the latest market attention-grabber.

Embrace the plan

We’re often our own worst enemies due to tendencies hard-wired into our psychology. Behavioral biases buried deep in our DNA rise to the surface during times we view as unprecedented. But the reality is that forces like these have been plaguing investors since time immemorial.

So, what’s a jittery investor to do? The key to succeeding in tumultuous times is to adhere to a comprehensive financial plan and investment strategy. Having a plan in place and working with a financial planner can help you block out the noise and stay on track toward your goals, no matter what comes along..

Jason Policastro is a private wealth advisor at Cornerstone Advisory and the chair of the Communications Committee at the Financial Planning Association of Maryland. He can be reached at jason@cornerstoneadvisory.com.

Read full article here >