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Here are 3 tips every young investor should follow to avoid emotion-based investing
Here are three ways to avoid having your emotions drive — and hinder — your investment decisions.
When it comes to investing, there's only one thing we can be sure of: No one can predict what will happen in the market.
Despite the countless investment concepts, books and data that exist out there, at the end of the day, we aren't any good at predicting when the market will go up and down. Investing gurus talk about risk and return, but expert Patrick Geddes argues that there are two conflicting emotions that ultimately end up driving our investment behavior: fear (measured by risk) and greed (measured by return).
"Learning about how your brain is wired and how your emotions drive your investing can actually be even more important than analysis," he explains.
Sometimes, these emotions get the best of us. Geddes calls this concept of making emotion-based investment decisions the "illusion of control."
"As investors, we imagine a kind of control over outcomes that doesn't match the unwelcome reality that stocks behave pretty randomly," says Geddes, who is the co-founder of investment management firm Aperio Group, former research director at Morningstar and author of the upcoming book, "Transparent Investing."
To protect yourself against your own worst instincts, check out Geddes three tips:
Tip 1: Brace yourself in advance for market collapses
Markets plummeting triggers only one thought in investors' minds: how much value their investments are suddenly losing. While it's human nature to want to react quickly to dips in the market, resist impulsively making changes to your portfolio out of fear and panic.
"We all feel awful when markets blow up the way they did in the tech collapse of 2000 to 2002 or the financial meltdown of 2008 to 2009," Geddes says. "The best advice for such times is to stay the course."
The market can just as well go up as quickly as it can go down. Keeping your cash invested throughout the fluctuations is what helps your money grow over time.
Reassure yourself that experiencing volatility is part of the price of putting your money in the market — and it will happen again. The best thing you can do as an investor when the market collapses is usually nothing. "Just ride out the storm, as terrifying as things may feel," Geddes adds.
Tip 2: For stocks, pick index funds
As a young investor, you may feel eager to find the next hot stock. After all, the stories of how people turned $1,000 into millions is appealing, Geddes notes. But the odds are heavily stacked against anyone trying to outsmart the market, even financial professionals.
"Emotionally, you may long for bragging rights if you happen to get particularly lucky. But your actual total wealth will be higher by going the boring route of broadly diversified index funds and acknowledging that, on average, the ability to pick the stocks that will outperform is just another illusion," he explains.
You might be surprised to learn that you'll likely perform much better with this dull and counterintuitive approach of investing passively through index funds. By using your brokerage account to buy diversified mutual and index funds, you take on less risk than when you buy an individual company's stock, and you can sit back while your portfolio grows over the long run.
Select reviewed over 12 online brokers that offer zero-commission trading and narrowed down the top six platforms for all sorts of investors:
These six offer the widest range of investment options, user-friendly technology, quality customer support and educational resources. (Read more about our methodology on selecting the best $0 commission trading platforms.)
Tip 3: Check your portfolio no more than once a year
You likely heard it first from Warren Buffet: Invest for the long term. Checking your portfolio no more than once a year will help you avoid any temptation to make updates to your investments as the market changes.
To best weather the market's ups and downs, Geddes agrees that you should leave your investments alone for the long haul, following the math rather than the excitement of the stock market.
"The more fixated you get on the daily news cycle, the more tempted you'll be to jump in and do something, again succumbing to the illusion of control," Geddes says.
Investing doesn't have to be complicated, and Geddes' three tips above demonstrate that. Know that market downturns will happen, and the best reaction is to not react. Your money is safest when you invest in diversified index funds held for the long term. And it's OK to go months without checking on your portfolio's progress.
The goal isn't to separate yourself from your emotions, says Geddes, but rather to understand how they play a part in your investment decisions.
"We can lead healthier lives — with healthier portfolios — the more we develop good habits, which are much easier to describe than to implement," Geddes says. "But at least that's the part where we do actually have control."
To determine which $0 commission trading platform offers the best services for consumers, Select narrowed down offerings to a list of 10 initial platforms. We then analyzed and compared each one based on the following factors:
- Account minimums
- Account types
- Account and advisory fees
- Customer support
- Expense ratios of available investments
- Selection of investments
- Trading fees
- Available technology, including mobile platforms
- Educational tools and resources
After reviewing the above features, we based our recommendations on platforms offering the widest range of investment options, robust educational tools and resources, user-friendly technology, as well as the lowest fees and expense ratios. We also looked into each company's customer support structure, available avenues of communication and app reviews.
Note that with all trading platforms, there are no guarantees you'll earn a certain rate of return or current investment options will always be available. To determine the best approach for your specific investment goals, speaking with a reputable fiduciary investment advisor is recommended.