Overcoming Emotional Decision-Making When Investing

Year after year, results from the annual Dalbar Inc. study of market returns reach the same conclusion; the average investor significantly under performs the S&P 500 over time.[1]

For the 20 year period ending on 12/31/2012, the S&P 500 averaged 8.21% a year, while the average equity investor returned only 4.25% a year over the same period.  Bond investors fared worse, lagging the Barclays Aggregate Bond Index by over 5% during the same 20 year period.[2]

What is the primary culprit behind the nearly four percent lag in performance for equity investors?

Dalbar concluded investors tend to make poor choices driven by emotions (see our piece on “Who’s Really More Emotional?”). Often, investors react too rapidly to both positive and negative news.  This overreaction leads to clients buying high and selling low, and ultimately underperforming over the long-term.

How do we overcome our emotions to achieve better performance?

 3 Keys to Overcoming Emotional Investment Decisions:

1.  Diversify:  The goal of diversification is to reduce risk.  This can be achieved by investing across asset classes that are not perfectly correlated.  To learn more about diversification, please CLICK HERE.

2.  It’s a Marathon:  Don’t fall into the trap of chasing performance or looking for the latest and greatest idea.  Focusing on the long-term approach to investing will help prevent you from making rash decisions. To quote Warren Buffett, “The ability to say ‘no’ is a tremendous advantage for an investor.

3.  Know Your Investments:  If you don’t understand an investment or strategy, don’t buy it.  During bear markets, it’s hard to think long-term if your portfolio is full of companies or strategies you don’t understand.  Focus on what you know and you’ll be better equipped to make informed, rational decisions.

By understanding why the average investor underperforms and by implementing these easy to follow-steps, you will be on your way to making better, more informed investment choices.

Should you have any questions about your current investments or would like to speak with an advisor at Beacon Pointe, please feel free to contact us at info@beaconpointe.com.

Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.

[1] Anderson, Tom.  Fund Investors Lag as S&P 500 Nears All-Time High. Forbes.com. March 28, 2013.
http://www.forbes.com/sites/tomanderson/2013/03/28/fund-investors-lag-as-sp-500-nears-all-time/. February 27, 2014.

[2] Dalbar, Inc. Quantitative Analysis of Investor Behavior Study. March 26, 2013. http://www.dalbar.com/Portals/dalbar/cache/News/PressReleases/QAIB_2013-Press_Release.pdf.  February 27, 2014.

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