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The Pitfalls of Emotional Investing, and How to Avoid Them


The market goes up. The market goes down. Volatility, sometimes extreme, is a fact of life. Successful investors understand this and know how to prepare and act accordingly. Here is what many of them do:

Avoid emotional investing – Knee-jerk reactions to market fluctuations can lead to buying high and selling low, making it difficult to stay on track and achieve long-term financial goals.

Remain invested in a diversified portfolio – A well-diversified portfolio may help smooth out the market’s inevitable highs and lows and help investors pursue their long-term goals.

Think long-term – Market highs and lows have historically evened out over the long term. Adhering to a lengthy time horizon may not always be easy, especially in a downturn, but it can be a valuable discipline.

Don't Get on the Roller Coaster

Emotional reactions to market fluctuations—especially fear, hope, and greed—can make it difficult for investors to stay focused and make rational decisions. Not surprisingly, the graphic depiction of emotional investing resembles a roller coaster.

Hypothetical example shown for illustrative purposes only. This does not represent the performance of any specific investment product.

Allowing emotions to drive short-term investment decisions may lead to selling low and buying high, classic mistakes that can make it difficult to achieve long-term financial goals.

One way to avoid this all-too-human behavior is to not fall prey to media coverage, especially during a downturn. The media often makes a big deal out of market volatility, and while it’s fine to stay abreast of this news, successful investors don’t overreact.

Another way to avoid emotional investing is by working with an investment advisor—someone who understands an investor’s tolerance for risk and long-term financial goals.

An accomplished advisor knows the need for dispassionate analysis in the face of market turbulence and can help investors create a portfolio designed to weather any condition. Two signature traits of such a portfolio are asset allocation and diversification.

The Value of Asset Allocation and Diversification

Sometimes confused, both are important because they can help minimize dramatic ups and downs in the market. Together, they form a stable foundation for a long-term investment plan.

Diversification does not guarantee a profit or protect against a loss in declining markets.

 

Long-Term Goals Require Long-Term Thinking

Investors with a lengthy time horizon are advised to have a durable portfolio that is positioned for the future. As this chart shows, the longer investments are held, the greater the likelihood that the range of returns will tighten and the potential for negative returns will decrease.

Source: FactSet. Past performance is no guarantee of future results. Average returns from January 1, 1997 through December 31, 2016. Returns for periods less than one year are not annualized. See page 4 for a list of representative indices. The indices are unmanaged, are not available for investment and do not incur expenses.

Keep in mind even the most brilliantly conceived long-term portfolio may not succeed if the investor falls prey to emotional investing. Another way to avoid it is through the discipline of dollar-cost averaging.

Dollar-cost averaging

Designed for investors with long-term objectives, this approach requires investing a fixed-dollar amount at regular intervals over all cycles of the market, regardless of the price. More shares are purchased when prices are low and fewer shares when prices are high.

The rewards of discipline

Market volatility can test the emotional fortitude of any investor. What’s required is the discipline to stay the course, knowing your portfolio was designed to weather turbulent times and that reacting emotionally may be counterproductive. Discipline is essential to helping investors achieve their long-term goals.

Successful investors may avoid pitfalls if they follow these investment fundamentals:

Avoid emotional investing

Remain invested in a diversified portfolio

Think long-term


Investing involves risk, including possible loss of principal.

AMG Distributors, Inc., is a member of FINRA/SIPC.

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