There’s nothing like some volatility in the stock market to test an investor’s ability to make rational decisions.
Whether share prices are heading up or down, it’s common for individuals to make mistakes that are driven by emotion, experts say.
“Investors tend to extrapolate,” said Dave Goodsell, executive director of the Natixis Center for Investor Insight. “They think that if the market is going up, it’s going to keep going up, and if it’s going down, it’ll keep going down.”
That can lead to other mistakes called out by financial advisors in recent research from Natixis Investment Managers, which canvassed 300 U.S. financial professionals — wealth managers, registered investment advisors, financial planners and wirehouse and independent broker-dealers.
While the major stock indexes headed higher in Wednesday trading, the climb came on the heels of consecutive days of heavy losses. The tech-laden Nasdaq composite index closed Tuesday at 10,847.69 in correction territory — down more than 10% from its high of 12,056.44 on Sept. 2. However, it’s up 20.9% so far this year.
Similarly, although the S&P 500 index shed 6.9% during the recent sell-off, its year-to-date return is 3.1% through Tuesday. The Dow Jones industrial average, however, is down about 3.4% for the year.
Where stock prices go from here is anyone’s guess. Yet if they keep marching higher, beware of a misplaced sense of euphoria — which was noted by 25% of financial advisors as a mistake made by individual investors.
Whether you’re a novice investor or have watched your investments go through the wringer more than a few times over the last several decades, here are some other mistakes to avoid.
Whether pegged as panic selling, emotional decisions or short-term focus, this category ranked first on the list of mistakes, with 93% of advisors in the Natixis survey citing it.
The basic problem, Goodsell said, is that these behaviors can yield poor financial results.
“Say the market’s down 10% and you say ‘I have to get out,’ you’re locking in a 10% loss,” Goodsell said.
Remember, the losses reflected in your day-to-day account balance are not final unless you sell. And, it can be hard to get back in the market and stay put if fear is driving your decisions.
“Whether the market is up or down, emotions get the better of us from time to time,” Goodsell said. “Keep focused on your long-term goals and how to achieve them.”
Inaccurate view of risk tolerance
Nearly half (45%) of surveyed advisors said failure to recognize one’s own risk tolerance is a problem. Primarily, it can cause the panic selling described above.
Risk tolerance has a couple of parts: How well you can stomach the inevitable ups and downs in the stock market and how long until you plan to use the money. Generally speaking, the longer a time horizon you have — i.e., you’re saving for retirement several decades out — the more can you afford to be invested aggressively in stocks and wait out periods of volatility.
The emotional side — whether you can sleep at night if your portfolio’s value drops — can be a different story.
“When markets get volatile, it causes a strong emotional conflict,” Goodsell said. “The challenge is to make logical decisions.”
More than half of investors (56%) say they’re willing to take on more risk to get ahead, according to a separate Netixis study done in 2019. However, more than 75% of them said they prefer safety over investment performance. In other words, many investors may be taking on more risk than they should.
“You need to know your own risk tolerance,” Goodsell said.
Half of the advisors surveyed said investors err by trying to time the market — ideally selling high and buying low by predicting what the market is about to do — instead of sticking to a long-term investing strategy (otherwise known as “buy and hold.”)
“There’s a fear of missing out that we tend to have, and we try to capture as much of the upside that we can,” Goodsell said. “But then the market goes down and we see our assets at risk and we run.
“So we lock in losses.”
Unrealistic return expectations
Many advisors in the survey (43%) say investors often expect far more growth in their investments than is realistic. In the 2019 Natixis survey, investors said they expected average annual returns of 10.9% above inflation, over the long-term.
Advisors say 6.7% is more realistic, Natixis research shows.
“You have to have realistic expectations of your investments,” Goodsell said.
Too much risk in pursuit of yield
For investors in search of steady income — for example, from bonds — low interest rates may cause you to eye higher-yielding investments. A quarter of surveyed advisors said focusing too much on the yield is a mistake.
Generally speaking, the higher the yield, the riskier the investment.
“Just understand that higher yield means more risk in your portfolio,” Goodsell said.