Despite popular Hollywood portrayals of how investing works — a smart suit and someone with the last name Sheen or Douglas usually does the trick — research shows that most of us still try to time the market, typically resulting in buying high and selling low. No one likes being told they're wrong, or that they don't have a grasp on the situation — this infographic created by Jemstep looks to examine why many of our buy/sell decisions are wrong, the damage it causes to our portfolios, and a better way to invest for maximum returns over the long run.
Investors thinking they know how to work the stock market by timing their investments are delusional in how well their portfolio is actually performing. To put it into context: The return of the average investor is 1.9% over 20 yrs — due to poor buy and sell decisions. Investors who simply invested — and kept — their money in the S&P 500 (INDEXSP:.INX) earned an average of 8.4% over the same period; with diversified portfolios doing even better — for a full breakdown, refer to the infographic below.
The true problem lies in the fact that the majority of buy/sell decisions are wrong; even if you think you're smarter than the masses. Barrons recently revealed that 85% of all sell or exchange decisions are incorrect. The major culprit of these investing blunders are emotional biases that drive investors to respond to the market's ups and downs. People have been leaning too long on the idea that it's best to sell stocks when they hit rock bottom, and then put their money in conservative assets like bonds when they are at the top.
A list of biases that explain such irrational buy/sell behavior are: loss aversion, mental accounting, overconfidence, anchoring, and sunk cost fallacy. These biases lead us to make decisions that ultimately hurt our financial standing. Buying
These biases lead us to make decisions (like buying high and selling low) that are clearly illogical, but feel right. But do they feel right to a loss of around $80,000 over 20 years? One solution that can help turn the tables on poor investing is to stick to a long-term investment plan that overcomes emotional biases. Not timing the market or getting caught up in short-term decisions will allow you to look at the bigger picture, and having a more diversified portfolio will help even more.
Roughly 90% of your portfolio's volatility comes from your assets allocation, not day-to-day micro decisions about when you buy or sell. So maintain a balanced portfolio, and you will be able to outperform average investors, and the S&P 500 as well.