It’s easy for a pundit on TV or a finance blogger to talk about the simplicity of investing.
That’s what many of them do, yet we constantly hear horror stories of people’s experiences investing in the stock market. Investing may not be complicated, but it sure is hard and we tend to make it harder on ourselves. As we have pointed out in the past, a huge part of investing is psychological.
At times, investing can feel like quicksand. The more you do, the more you sink. To compound that problem, it is human nature to continue to make the same mistake over and over again.
Following the Herd There are plenty of common sayings and quotes in the finance industry, but one that always made me laugh was “buy low and sell high.”
If only it were that simple. It’s not that there is anything “wrong” with this saying. The problem is that people don’t truly understand what it means. How do we know when it’s low enough or high enough? How are we defining these terms?
Let’s examine. The idea of buying low falls into the area of value investing.
The basic concept of value investing is that you buy it when it’s “on sale.” When everyone else is selling, you are buying and vice versa. Think of it as bargain hunting.
Ideally, the value investor looking to “buy low” is seeking out what they believe to be a healthy company that is severely undervalued for whatever the reason. They would buy this stock low and then patiently wait for the “herd” to catch up. Sure, many do some form of this. But when looking at the market as a whole, we tend to do the exact opposite. We chase trends and follow the herd.
This chart is a perfect illustration of one of the many psychological roadblocks we have as investors. We want to buy low and sell high but that goes against every instinct we have. We sell a company when the price is falling because we are scared of losing more money and we buy a stock when it is rising because we have a fear of missing out.
Goals and Risk Tolerance
So what can you do to avoid these issues?
- Understand your goals and risk tolerance: Before you can get started investing, it is imperative to understand what it is you are trying to accomplish and how much risk you are comfortable taking. Once you have that figured out, you can create an investment plan that is appropriate for you to help you achieve those goals.
- Avoid market timing: Instead of trying to time it perfectly and squeeze every last cent out of an investment, focus on building a diversified portfolio of stocks and bonds that give you the greatest chance to succeed over the long term.
- Leverage your resources: We’ve written previously about how investors can be their own worst enemy. Having a great financial and investment plan is irrelevant if you don’t have the mindset to follow through and stick to it. Becoming self-aware of these issues is a great first step. If you know that this is an issue for you, speak with a financial advisor. Just make sure that they have your best interest in mind at all times.
In summary, the most important piece of advice to take away from this is to start by understanding your goals and risk tolerance. At that point, you can work to create an investment plan that makes sense for you and avoid making many of the behavioral mistakes pointed out in this article. (For more, see: Which Investor Personality Best Describes You?)
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