Surging stocks make investors feel smart. Pay heed to the many ways you can go wrong.
By MORGAN HOUSEL
With the S&P 500 near an all-time high and the Nasdaq Composite approaching the 5000 mark for the first time since the dot-com bubble, it may feel like investing is easier than ever. It is times like these when paying attention to what not to do becomes crucial.
How do you become a better investor? Learn the basics. Study the masters. Seek out quality advice.
But some of the most important investing moves are the actions you don’t take, the forecasts you don’t read, the advice you ignore and the feelings you reject.
Here are nine mistakes to watch out for:
Feeling certain. Thinking that you “know” what some stock, or the market, is going to do puts you on the expressway to regret. There are no certainties in markets, only probabilities. It is far better to trust someone who says there is a 60% chance that the market will rise this year than someone who guarantees it. The graveyard of poor investing decisions is filled with people who left no room for error in their forecasts.
Extrapolating the recent past into the future. People have a burning desire to forecast, and minds have a burning desire to follow the path of least resistance. The easiest, and often most common, forecast is to assume the future will resemble the recent past. After stocks rise—like they have recently—investors assume they will keep rising. After stocks fall—like they did in 2008—they extrapolate and forecast further declines.
This may work for a while, but market turning points tend to come when conviction that a bull or bear market will continue is at its highest. While forecasting moves in straight lines, history moves in cycles and sudden spurts.
People selling financial products on commission. As the saying goes, “Never ask a barber if you need a haircut.” The answer is perfectly predictable. As a corollary, never ask a commissioned broker whether buying or selling a financial product is a good idea.
Self-interest is one of the most powerful forces in the world and can influence otherwise good, honest people to put their pocketbook before yours. Uncommissioned, fee-only financial advice is the best option in most financial matters.
Feeling smarter after the market rises. Everyone loves a bull market. You can make money without much effort. But that feeling can be dangerous, because it can increase your confidence more than your ability.
If you have done great as an investor over the past five years, check your ego at the door. Almost everyone has done well. The true test of investor skill is how you react during times of panic and distress.
Feeling victimized after the market drops. After every big market drop comes the finger-pointing. People blame Wall Street, high-frequency traders, politicians and stockbrokers. The truth is anyone owning stocks has signed up for a game with a history of repeated busts, crashes, pullbacks and bear markets. It is the norm.
The more victimized you feel after a market drop, the less likely you are to learn how normal and inevitable these drops are. Learn more and complain less, and you will be better off in the long run.
Impatience. Investing requires, more than anything, patience and discipline. But it often attracts the impatient and impulsive.
Markets tend to produce strong long-term returns, but the desire to pull those returns forward and earn more money now, today, has caused more misery and remorse than perhaps anything else in this business. Lengthening your time horizon is one of the best things anyone can do to improve his or her investment outcomes.
Letting partisan views guide your investment decisions. Don’t let your political views influence your investment decisions. By all means, use your morals to influence your choices—say, by investing in green energy, or avoiding tobacco companies. But realize that markets are ultimately driven by long-term corporate earnings, while politics are ultimately driven by the two-year election cycle.
Worrying about things you can’t control. You have no control over what the Federal Reserve will do next, who will win the next election, whether a company will meet earnings expectations, OPEC’s oil-output decisions or the next monthly jobs report.
You do have control over your own expectations, asset allocation, reactions to market volatility and the people you choose to listen to for financial advice. Use the time and energy devoted to the former to improve the latter.
Refusing to change your mind when the facts change. In financial punditry, points are awarded for confidence and consistency. People love a pundit who pounds the table, foretelling the future without wavering an inch. Indeed, in 2013 two economics graduate students from Washington State University showed that confidence trumped accuracy when measuring the popularity of pundit predictions.
While confidence and consistency make for good entertainment, humility and open-mindedness makes for better advice. The analyst who isn’t afraid to say, “I don’t know” and “I’ve updated my forecast now that information has changed” may never be popular, but he or she is the one you want to listen to.
Morgan Housel is a columnist at the Motley Fool.
This article originally appeared on The Wall Street Journal online at www.wsj.com on Feb. 26, 2015.
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