It’s not a dangerous time because of a crisis or volatility. It’s dangerous time because investors start to become overconfident.
We have not had a substantial stock market correction in some time. One thing that always happens during these quiet stretches is that investors become lulled by good times. That sometimes gives a false sense of security. That can lead them to behave rather badly.
I’ve seen plenty of investors get themselves in trouble during these quiet good times. I often compare it to the spring break college student dancing on the hotel roof. Sooner or later, something really bad will happen.
Here are a few classics I’ve seen over my years:
1. Borrowing to invest. I really don’t know what people are thinking here. I’ve seen them borrow on credit cards and home equity lines. Most of the time they think that the trade will go their way and they can pay the money back. My advice don’t ever do this. It never works out the way you think it will.
2. Not doing your homework. Never, never, never invest in something you don’t understand. If your advisor has made an investment for you, make sure you “get it” before you buy. You must do some due diligence on your own before investing. Some of the worst mistakes I’ve seen have come from buying and investment that people had no idea of what it was or how it worked.
4. Frequent trading. This is truly a recipe for disaster. Trading frequently to try to pick up some gains. The vast majority of investors that have done this have blown up their accounts. Trading more does not equal more return. Do your homework, trade when necessary. If an investment has met your goal or something negative has taken place, that is good time to trade. In other words, have a defined strategy in place before you invest.
5. Taking too much risk. Overconfidence has led many investors to become more aggressive. Their logic is that if I’m making this return, then if I’m more aggressive I’ll make more. It’s true, but if the market goes the other way, then you can lose more. Stick with your risk tolerance through good and bad markets.
6. Impatience. Impatience will often lead us to use emotion rather than logic. Investing and emotion don’t mix! Impatience will get an investor to trade too early, and therefore miss out on potential gains. In fact, impatience can cause you to lose more money from selling too early and not waiting on the investment to rebound. Patience is a virtue, and a necessity with investing. Stay calm.
7. Going it alone. Of course I’ll say this one is a mistake! Seriously though, when times are good, investors get overconfident in their ability to manage their own money. Everybody is an expert when things are good. It all looks so simple. It doesn’t help with all of the commercials, web sites and ads encouraging investors to drop their broker. Let that first large loss rack up, and the emotions start to kick in. Then the panic starts, and more bad decisions. A great financial advisor will prove his worth in bear markets. Calls and meetings that are all designed to reinforce your strategy and keep you on track.
So those are the classic bad behaviors that I’ve seen. Yes, I believe this is a dangerous time in the market. When investors take more risk, become impatient with returns, and start talking about, or acting on, managing their own investments. Proper planning and investing is an art as well as a science. Don’t give in to overconfidence.
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