7 mental tips investors should master
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Investing is a must if you’re looking to build wealth and achieve long-term goals such as retirement. At its core, investing involves sacrificing present consumption to increase future consumption. However, despite its supposed simplicity, investing is not easy in practice. Emotions can cloud rational judgment which can lead to poor decisions and ultimately poor outcomes.
Here are some mental tips for navigating the investing landscape that may help you keep your emotions in check and make it more likely that you’ll reach your investing goals.
7 mental tips each investor should have
1. Stay calm: Volatility is part of investing
Many people are invested in stocks because of their attractive long-term return potential and rightfully so. The S&P 500 Index has historically delivered an average annual return of approximately 10 percent, making funds that track the index a staple of retirement portfolios. But people rarely stop and think about why these returns are available.
Stocks don’t go up 10 percent every year. The returns tend to be quite volatile, sometimes rising swiftly and other times dropping dramatically. But this volatility, or risk, is what creates the opportunity for attractive long-term returns. So when you see stocks dropping or entering a bear market, know that this is expected and is part of why you’re compensated so well for owning stocks.
Some investors have the instinct to sell when things start getting bad, but by staying calm and staying invested, you can reap the future rewards.
2. Set realistic goals
A key part of achieving your investment goals is setting realistic goals in the first place. If you start out thinking you’re going to generate investment returns of 15 or 20 percent each year, you’re likely to be disappointed and that may lead to poor decision making, such as taking on excessive risk.
Return expectations should be driven by the investments you hold in your portfolio, but for most investors with stocks making up the majority of their portfolio, long-term returns of 6 to 8 percent is a reasonable assumption. You may be at the high end or even above that range early in your career if stocks make up 100 percent of your portfolio, but the returns may come down as you get closer to retirement and your portfolio shifts more toward bonds and other fixed-income securities.
3. Ignore short-term predictions
The investing world is filled with people claiming to be experts and willing to make predictions about where stocks, the overall market or the economy is headed next. While these predictions can be entertaining, the truth is that no one can accurately predict the future. Oftentimes, the people making the predictions don’t get paid on whether they’re right or wrong, so there aren’t any consequences for being wrong.
It can be tough to ignore these predictions, because they’re often made by impressive individuals who make strong arguments. But ignoring the temptation to trade on every new prediction by market commentators will likely lead to a better outcome down the road.
4. Saving is a key part of any investment plan
Investing is appealing to many people because of its power to significantly grow wealth over time. By investing at high rates of return, the power of compound interest can transform a small amount of money into an enormous amount over time. But the rate of return you earn on your investments is a difficult variable to control. One variable you can control is the amount of money you save.
While it’s true that you will need to save less if you earn a 15 percent annualized return for 30 years compared to an 8 percent return, you can’t predict the rate you’ll earn in advance. A better approach is to save money with the assumption you’ll earn a lower return and then be pleasantly surprised if the return ends up being higher. You’ll end up with more money and may even be able to retire early or live a grander lifestyle in your golden years.
5. Don’t try to time the market
When the economy starts to slow and concerns about a possible recession increase, it can be tempting to sell a portion of your investments and wait for better times. However, this strategy has a few flaws.
First, assuming you can tell when a recession or slowdown is coming is risky. Many times concerns about a slowdown end up being just that – concerns, and the recession never actually happens. People predict more recessions than actually happen, so you could be getting out of the market for no reason.
Secondly, assuming that if stocks do go down due to a recession, you can identify when to get back in before it recovers is challenging. This often involves reinvesting when the economic outlook is bleakest. Can you imagine the unemployment rate hitting new highs, and corporate earnings are falling? For most people, the answer is no.
Consistently investing over time through dollar-cost averaging is likely a better strategy than timing the market.
6. Admit mistakes and move on
Studies have shown that investors tend to hold on to losing investments for too long, in the hope of recovering or breaking even. However, this can be damaging to your portfolio by dragging down your overall returns and failing to move the money into a more promising opportunity.
No one likes admitting they were wrong, but recognizing it quickly and accepting you made a mistake is a good investing habit to adopt. People sometimes want to wait to sell a losing investment until it gets back to where they bought it, but that may never happen if the problems that made it a loser in the first place persist.
“A very important principle in investing is you don’t have to make it back the way you lost it,” legendary investor Warren Buffett told shareholders at the 1995 Berkshire Hathaway annual meeting. “And in fact, it’s usually a mistake to try and make it back the way that you lost it.”
7. Don’t think you know more than you do
Investors also tend to be overconfident, which can result in taking on an inappropriate level of risk. Overconfidence may lead an investor to think they can beat the market by choosing individual stocks or making a few stocks a particularly large percentage of their portfolio. Beating the market is extremely difficult – most professionals fail at this task – and concentrating your portfolio in just a few stocks increases your risk.
It’s important to note that slow and steady wins the investing race, even if it’s not the most thrilling approach. Don’t try to swing for the fences when you think you’ve found a sure winner. There’s always the chance that you’re wrong and preparing for this likelihood will ensure that you don’t jeopardize your long-term goals with one or two wrong moves.
Just about everyone will need to invest in order to meet their financial goals. Investing may help lead you to wealth and independence, but there are many opportunities to trip up along the way. Establish a plan, either through a financial advisor or on your own, and work hard to stick to that plan without being swayed by market volatility, short-term predictions or other distractions. Mastering these tips may help you develop an ideal mindset for investing and make it more likely that you’ll meet your long-term goals.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.