Since young age I have always been fascinated by philosophy and how human minds work. Even when facing the most unreasonable thoughts, digging deeper, there is (in the vast majority of the cases) a rationale behind.
So, why do 75+% of the investors lose money?
I can pin point at least three reasons: lack of strategy, poor portfolio asset allocation and emotions.
In this post I’ll focus on the emotion part that quite often makes us (yes, I did several mistakes when I started) buying the highs and selling the lows.
Buying low comes from an investment philosophy known as value investing. The basic concept of value investing is to buy investment instruments when they are “on sale.” That means buying when everyone else is selling (and prices are down) and vice versa. A smart value investor buys low, then patiently waits for the “herd” to catch up. Unfortunately, most investors tend to do the exact opposite: tend to chase trends and follow the herd.
A huge part of smart investing is psychological and the image below (sorry for the quality) illustrates one of the many psychological roadblocks investors have.
We may want to buy low and sell high, but that goes against our instincts and biases. When a stock/ETF is falling, we dump it. When a stock/ETF is rising, we buy it. We sell when the price is falling because we are afraid of losing more money; we buy when it is rising because we have a fear of missing out. To compound the problem, most investors are not experts at realizing when something high or low “enough.”
So what to do to avoid the drawbacks of trying to buy low and sell high?
• Understand your goals and risk tolerance: it is critically important 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 and comfortable enough to keep you from impulse buying high and panic selling low.
• Avoid market timing: instead of trying to time investments perfectly and squeeze every last cent out of each one, 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: having a great financial plan and a diversified portfolio is irrelevant if you don’t follow through and stick to it. Becoming self-aware of the pitfalls is a great first step
Stay tuned for a couple of posts to come about: strategy definition and portfolio allocation.
note: part of this post was originally posted on Investopedia
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