It's difficult to do, but you should try to stay focused on your long-term goals and investments. However, studies show investors let their emotions dictate when they buy and sell.
Almost every day, economic news both in the U.S. and Europe adds to general feelings of uncertainty and, in some cases, outright anxiety on the part of investors. The volatility we have seen in late 2011 and to date in 2012 has added to this uneasy feeling.
The daily papers trumpet the crisis usually with some negative element about the debt ceiling issue in the U.S., the slow pace of U.S. economic recovery, and/or the European crisis. The 24/7 talking heads on certain cable news channels (and on some networks) don’t help the situation by emphasizing short-term trading and investments.
It’s difficult to do in this environment, but you should try to stay focused on your long-term goals and investments. This approach would have served investors well after the dramatic market decline in 2008 as a result of the rebound we experienced in 2009 and 2010. But this is easier said than done.
Behavioral finance studies show that investors do have a tendency to let their emotions get the best of them and subsequently will buy when markets are rising and sell when markets are declining, which is the exact opposite of what you should be doing in order to achieve and grow wealth over the long term.
Quantitative Analysis of Investor Behavior
DALBAR is a leading financial services market research firm and its yearly report, , supports the idea that investors need to think with their heads and not their hearts.
In the report for 2012, DALBAR shows a sizable gap in the average investor’s 20-year annualized return compared to the major indices. For the past 20 years, the average equity investor underperformed the S&P 500 by 4.32% (3.49% vs. 7.81%) while the average fixed-income investor underperformed the Barclay’s Aggregate Bond Index by 5.56% (0.94% vs. 6.50%).
“The gross underperformance of the average investor in 2011 clearly displays what has been the case for over 25 years — irrational decisions lead to inferior returns,” DALBAR writes. “This is not just the case of a year-by-year basis, but for intermediate and long-term results as well.”
Collaborating with a trusted advisor who can work with you to develop an investment strategy that you are comfortable with will help you stay the course. In fact, many individual investors hire professional advisors for the primary purpose of protecting themselves from their own emotions. Many see more bumps in the road until some of the larger issues facing global markets come closer to resolution. By all accounts, it could be a while.
In the meantime, it’s important to remember that holding for the long term may well be your best course of action — each person’s situation is different, however, and your financial professional can advise.
Matthew DiQuollo is a financial analyst at Brinton Eaton, an SEC-registered investment advisory firm in Madison, N.J., serving individuals and institutions throughout the U.S. Matthew works closely with Brinton Eaton’s financial advisors to develop strategies and plans for clients to achieve their lifestyle goals. He can be reached at firstname.lastname@example.org or (973) 984-3352.