Start Out Small and Diversify
Many people feel paralyzed about investing, especially if they’ve invested little or nothing in the market before.
Investors are bombarded with conflicting messages about whether the stock market will continue hitting new highs or is a house of cards waiting to self-destruct. If the experts are so unsure, it’s understandable that the average investor can’t decide how or when to invest.
While people don’t want to miss out on future gains, they also don’t want to look foolish by buying at record highs before a crash. But looking at it that way almost guarantees procrastination. Short-term market moves don’t matter a lot.
Many people hold a misconceived notion that you have to jump into and out of the market at the right time. While the market can be a roller coaster, so long as you have a long enough time horizon, it’s worth the ride.
To overcome paralysis and indecision, start out small. Investing isn’t an all or nothing decision. Putting small amounts of money to work over time reduces your market-entry risk and is an effective way to conquer investor paralysis.
Diversification reduces risk and can increase your comfort level. While large-cap U.S. stock funds should be a core holding, they’re not the only game in town. Investors should also invest in bonds, small caps, natural resources and real estate funds. They should also include foreign stock funds in the mix. I recommend having about 35 percent of your equities in foreign stock funds.
Developing a long-term investment strategy and maintaining your investment mix regardless of market conditions is a better way to ensure success than trying jump into and out of the market.
Besides paralysis, here are some other common cognitive traps:
• Recency. This is the assumption that conditions created by a recent event will persist or recur into the future. Performance in the recent past is arguably the least useful information about an investment. But recent performance data is easy to understand and can be dramatic.
• Overconfidence. In Garrison Keillor’s mythical Lake Wobegone, all the children are above average. Most investors believe they too are above average—and less overconfident than other investors to boot. If you’re convinced you are a mini-Buffett, you may put too much money in one stock that can’t lose. You may also try to time the stock market instead of sticking to a long-term plan.
• Familiarity. Many people invest most of their money in areas they feel they know best, rather than in a properly diversified portfolio.
* Loss aversion. Investors often feel the need to make a change to their portfolio when markets are falling. Inaction can feel neglectful or foolish, especially if everyone else is furiously taking action. But making changes on the fly is often the worst thing you can do.
- Fortune-telling. One of the biggest mistakes investors make is trying to trade based on a prediction everyone accepts. If you expect a recession based on something you read in The Wall Street Journal or heard on CNN, stay calm. That possibility is already baked into the current market price of investments. Trying to avoid the next market meltdown or identify the next hot market is a false hope.
Ben Sullivan, Certified Financial Planner (CFP©), is a client service and portfolio manager with Palisades Hudson in Austin, Texas. He wrote the chapter on the topic in the book “Looking Ahead: Life, Family, Wealth and Business After 55.” More information is available at www.palisadeshudson.com/book. Chapters on investor psychology and estate planning can be downloaded free.
Follow Sullivan on Twitter @BenCSullivan.
Palisades Hudson Financial Group is a fee-only financial planning firm and investment manager based Fort Lauderdale, Florida, with about $1.4 billion under management. It offers financial planning, wealth management, and tax services. Its Entertainment and Sports Team serves entertainers and professional athletes. Branch offices are in Stamford, Connecticut; Atlanta, Georgia; Portland, Oregon; and Austin, Texas.