Tag Archives: American investor

Inside the mind of the American investor

We’ve learned a lot about investing behavior in the last 15 or 20 years. Investors, left to their own devices, tend to trade more than they should. For some investors, this is probably due to over confidence in their ability to trade. People hold on to their losing investments and sell their winners and, to some extent, this makes emotional sense. When you sell at a loss, you feel a bad; when you sell for a gain you think ‘yeah I nailed that one.’ But, especially in taxable accounts, it’s a bad strategy. You should be delaying taxes, not accelerating them.

Another big thing that investors tend to do is chase performance. Investors buy the thing they wished they bought last year. Unfortunately, this is basically an attempt to time the market, which is generally ineffective. Investors tend to buy at peaks or near peaks and sell in troughs. This doesn’t serve them well even though it’s easy to understand why they do it.

One bias that a lot of investors have is that when it comes to buying stocks, they tend to buy things that catch their attention. They buy things that are in the news, that they read about, someone tells them about. Now if you think about it, there are thousands of stocks to choose from and investors generally can only buy a few. One of the ways that they narrow down the set is by focusing on the stocks that catch their attention, but those are not necessarily the best stocks to be buying.

The best course of action for the vast majority of individual investors is to buy a low-cost, well diversified mutual fund. Index funds or other passive investing tends to outperform active investing. Keeping your fees low is really important; that’s like money in the bank. Be sure you’re diversified and don’t spend your time trying to beat the market.

One way advisers can make use of behavioral finance is to sit down with your clients in advance, in a good calm time and talk about some common investor behaviors that can sabotage their portfolios. Especially behaviors like selling in a panic or deciding to buy that hot stock or asset class. Having the discussion before your client actually experiences it allows you to refer back to it and say ‘remember when we talked about this and I explained my investment philosophy is long run, buy and hold, don’t chase the latest performance, don’t panic when the market goes down.’ Having that discussion in advance can be really helpful.