If a business wants to increase sales, they’ll often run a deal to entice customers to buy.
Deals work because customers get more bang for their buck. This concept makes sense and is widely accepted among customers and companies—when things go on sale, it’s a good time to buy. But unfortunately, in the world of investing, it’s not always as intuitive.
When the market drops, stocks trade at lower prices, offering a discount or sales price to buyers.
But, rather than buying more shares at lower prices, many investors get fearful and make the big mistake—selling when they should be buying. This causes many investors to lock in steep losses and miss out on a potential buying opportunity while the market is down. So how can investors avoid this big mistake?
Here are three ways to avoid the biggest mistake many investors make.
1. Zoom Out and See the Big Picture
Carl Richards, a financial planner and author of The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money, is widely recognized in the investment community for his work on behavioral finance.
Carl coined the term the behavior gap, which describes the difference between what investors should earn in the market versus what they actually earn due to their behavior. When Carl was a financial planner, he used to take out a sharpie and a piece of paper to help illustrate and explain various financial concepts to his clients. One of his best drawings is all about zooming out and seeing the big picture.
In the drawing, Carl has two charts. The one on the left is a smooth line that goes up and to the right with “5 years” above it. The other is a zig-zagged line going up and down aggressively, with the words “5 days” above it. Below, Carl simply writes, “you decide which one to focus on.”
His point is simple but effective.
Over long periods, the market is pretty consistent—creating value for investors while moving up and to the right. But, if you zoom in on any particular day, the market can feel out of control because of its high levels of volatility. So, as an investor, you can decide to zoom out, knowing that over time you’ll be rewarded for staying invested in the market, or you can zoom in, experiencing the extreme volatility of the market in the short run.
By zooming out and seeing the bigger picture, you’ll be able to increase your odds of staying invested over the long run and capture the total return that the market has to offer. Investing for doctors doesn’t have to be difficult if you follow this principle.
2. Automate Good Investing Behavior
One of the most effective ways to avoid a big mistake is to automate good investing behavior.
A great example is setting up automatic contributions over a set period, often called dollar-cost-averaging. The idea is simple: rather than invest sporadically when you feel like it or have extra money, you set up automatic contributions to your investment accounts. This is one of the most effective ways to consistently build wealth over long periods.
By setting up automatic contributions, you are winning in several ways.
First, you are removing emotion from the equation. Part of our wiring as humans makes us risk-averse, a survival tactic that has developed over the ages. This means that our wiring can push us into fight-or-flight to protect us when we see trouble in the markets. But, while this response can be life-saving when faced with physical danger, it can be very counterproductive to our investing success.
Automatic contributions take the emotion out of the equation because the investment contributions happen automatically each month, no matter what the market is doing.
Second, by dollar-cost averaging into the market, you can continue buying when the market goes down, purchasing more shares with each contribution. This allows you to reap the benefits of a market downturn, buying when asset prices are down and locking in bargain prices. This can boost your investment returns because the market tends to offer above-average returns after a downturn or bear market.
By automating good investing behavior, investors can avoid the big mistake while reducing their behavior gap.
3. Revisit Your Asset Allocation Over Time
Lastly, investors should revisit their asset allocation over time to avoid the big mistake.
Asset allocation is the mix of stocks and bonds in your investment portfolio. The right asset allocation will vary by investor and is typically decided based on your goals, age, timeline, and personality. But, many investors mistakenly think that their asset allocation is a one-and-done decision.
Instead, investors should continue to revisit their asset allocation over time, making adjustments as needed. This has a couple of benefits.
First, revisiting your asset allocation over time means reevaluating your financial goals and situation. This has various benefits as it forces investors to sit down and get clear about their situation, goals, and progress towards their goals so far. This is a perfect opportunity for investors to update their financial plans and asset allocation to fit their new objectives or situation.
Second, by revisiting your asset allocation over time, you can better position your assets to match your current risk tolerance.
Typically, as investors get closer to their financial goals and retirement, they dial down their risk—allocating more of their portfolio to bonds, and less to stocks. That’s because the stock market can be volatile in the short run. So, as investors approach the date they’ll begin withdrawing from their investments, they want to ensure their portfolio is reasonably stable.
The critical thing to remember is that investors shouldn’t wait until a market downturn to adjust their asset allocation because this often means they will be shifting out of stocks while they are down rather than up. Instead, it’s better to review your asset allocation periodically as your situation changes rather than reactively because of market volatility.
IMAFS Is Here to Help
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