Investing in the stock market provides you with an opportunity to put your money to work, seeking to earn an impressive return. Historically, the Standard and Poor's 500 Index has returned close to 10 percent on an average annual basis.1 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 2015 report from DALBAR Inc. showed that the average investor underperformed the S&P 500 by 3.6 percent.2 In 2016, the gap widened: The S&P 500 returned about 12 percent, while the average investor saw only about a 5% return.3
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) may 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, less when the price is high. Of course, a program of systematic investing does not guarantee a profit or protect against losses in declining markets. An investor should consider his or her ability to continue making 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.”4
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 this 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.
This educational, third-party article is provided as a courtesy by Michael Damon, Agent, New York Life Insurance Company. To learn more about the information or topics discussed, please contact Michael Damon at 508-321-2101.