Investing in the stock market provides you with an opportunity to put your money to work.
Historically, the Standard and Poor’s 500 Index has returned close to 10% on an average annual return. Of course, past performance is no guarantee of future results. But most investors fail to take full advantage of this opportunity. In fact, they often earn considerably less than the average market return.
A recent report from DALBAR Inc. showed that the average investor in 2018 lost twice the amount of money compared to the S&P. For example, the average investor lost 9.42% in the S&P 500 index which only was down 4.38%. Even during positive months like August 2018, when the S&P was up 3.26%, the average investor could not beat the market.
Why does this happen? There are three big mistakes investors tend to make over and over again.
Mistake 1: Trying to time the market
It’s impossible to predict when you should sell ahead of a downturn or start buying before a resurgence. When investors try to time the market, they often miss the mark, buying high or selling low or both. In the process, they negatively affect their potential return.
People who think they know that the market is about to drop (or make a comeback) might be kidding themselves. No one knows for certain what will happen next. What is predictable is that the market will experience periodic volatility.
So, instead of trying to time the market, you can plan for volatility by engaging in a long-term investment strategy and using dollar-cost averaging — purchasing a certain amount of an investment on a set schedule. That way, you’ll be purchasing more stock when the price is low and less when the price is high.
Of course, a program of systematic investing does not ensure a profit or protect against losses in declining markets. An investor should consider her ability to continue purchases during periods of declining prices, when the value of their investment may be falling.
Mistake 2: Reacting emotionally
Warren Buffett, one of the most successful investors ever, famously advised against letting emotions sway investment decisions when he said, “Be fearful when others are greedy and greedy when others are fearful.”
It’s easy to feel confident and excited about investing when markets go up. It’s also natural to experience panic when markets drop and you start seeing losses in your portfolio.
But giving in to these emotions leads most investors to sell low (when the market goes down, and people are worried about “losing” money) and buy high (when the market goes up, and securities are more expensive).
Mistake 3: Believing you know more than the market
Most economists and financial experts believe the stock market is efficient. This means the prices of securities in the market reflect their actual value.
But some investors act on hunches and predictions about what the market (or specific securities within it) will do next. Remember that professional investors and fund managers have access to an incredible amount of information that they use to make investment decisions, and that information is not readily available to the average investor.
The bottom line
You can avoid these three common mistakes by contributing consistently to your investment accounts each month (regardless of what the market is doing), assuming that you can afford to do so, working with a financial professional who can keep you calm and thinking rationally when you want to react emotionally and sticking to your overall financial plan and investment strategy instead of trying to guess the next hot stock.
Claire Damgaard is an agent with New York Life Insurance Company in Dubuque.