When advising beginner investors, most veterans focus on one important lesson that has nothing to do with numbers and technicalities: emotion is the enemy of investing. Whenever you’re executing trades and planning your long-term investment strategy, you should try to set aside all emotions and focus on hard data alone.
However, leaving emotions aside can be incredibly difficult, especially as a beginner. When you factor your own personal goals into play and also consider the social or environmental impact of your investment (as is the case with impact investing), it’s impossible to be completely devoid of emotions. Optimism, thrill, greed, fear, and caution are inevitable, so does this mean you will never reach your goals?
Not at all. Trading and investments will always have an emotional component to them, but the key to success lies in acknowledging and mastering these emotions and not getting caught on an irrational rollercoaster. More specifically, these five pitfalls that can prevent you from maximizing profit and making good decisions:
Confidence is a good trait to have in finance, but over-assessing your skills can be equally dangerous. Although one might assume that overconfidence only appears in veteran investors with a high net worth, it’s actually fairly common among beginners too, after they make a few successful moves.
In an extensive study, James Montier asked 300 professional fund managers if they believed they were good at investing. The results were perplexing: 74% believed that they were above average at investing, 26% believed they were average and not one respondent said that they were below average. Statistically, that’s impossible because if everyone were at least average at investing, we would only have success stories.
This is called overconfidence bias and it can harm your strategy in the long run. Overestimating your knowledge of the market feeds the illusion of power and makes you overlook important details. The famous even said in a Forbes interview that he always factored in the possibility of being wrong and that helped him avoid many bad decisions.
So, no matter how successful you’ve been so far, have realistic goals and don’t overestimate the odds of something happening simply because the result would be in your best interest.
2. Fear of loss
Loss is unavoidable when investing, but that doesn’t make it more pleasant. Studies have shown that the pain of a loss is twice as strong as the happiness of winning and that this can be one of the biggest impediments of building wealth. However, if you want to become a successful investor, you have to redefine your relationship with failure and understand that occasional losses aren’t the end of the world.
On the contrary, the loss is one of the most important self-growth tools you have at your disposal. Losses can help you understand what you did wrong, re-examine your strategy, and start again with a new perspective. In times of economic turmoil, it’s easy to give in to herd fear without understanding the context but that can affect you in the long run because you’ll make rushed decisions.
Instead, acknowledge your fear and where it stems from and be analytical about the whole process. Learn to manage fear through risk-aversion strategies and, most importantly, avoid making uneducated decisions based on the news.
3. Chasing past performance
If you’ve just started your investment journey, you probably landed on an article about the top 10 stocks and investment opportunities of a certain year. But while that may be a good starting point in understanding what’s profitable, it is by no means a de-facto guide. In fact, last year’s big winners aren’t necessarily the ones you should be following and chasing their past performance and prevent you from building wealth.
When analyzing top-performing funds from the previous years, you’ll see that most of them fail to ride the wave for future gains and Standard & Poor’s Dow Jones Indices show that only a small percentage of domestic stock funds deliver similar performance over a 12-month period.
Unfortunately, past performance is rarely an indicator of future results and if you want to secure your wealth you need to diversify your portfolio and have realistic expectations. According to a McKinsey report, future investments will yield about half the return we’ve come to expect.
To balance this, you can consider alternatives such as increasing your cash flow and talking to a professional about investment trends and opportunities.
4. Failure to read the market sentiment
The market sentiment is the overall attitude of investors towards particular security or financial market. This “crowd psychology”, if you will, is strictly tied to the activity and price movements on a market. When investing, you can use FX market sentiment to own advantage but there are few important things you should consider.
First of all, understanding the market sentiment can be tricky for a beginner because there are a lot of things going on that could affect the market but not all of them will. In the beginning, you should focus more on major releases from the central bank and ignore the noise from retail companies.
Secondly, you have to spot new sentiment trends before it’s too late. More often than not, waiting for more than 48 hours to act on a sentiment won’t yield the expected results. And thirdly, if you don’t understand the moves of the market yet, try to take very few risks and focus more on technical analysis.
5. Neglecting to rebalance your portfolio periodically
Although rebalancing can be difficult to execute, forgetting about your portfolio and leaving it as it is for more than two years can affect you in the long run. It can also feel wrong to sell your best assets, but buying low and selling high reduces risk and helps you build wealth.
Adding an asset to your portfolio doesn’t equal guaranteed success so once a year, you should have a closer look at it, assess its performance, and rebalance it if necessary.