How to avoid making the same investing mistakes as everyone else
Aaron Clarke is a certified financial planner and wealth advisor at Halpern Financial, a fee-only, independent, fiduciary registered investment advisory firm in the Washington, D.C., metro area.
As markets crashed in March, people went a little crazy. They sold stocks to hide in cash. They sold bonds to hide in cash. They even bought an apocalyptic amount of toilet paper to use while they were selling everything to cash.
But turning paper losses into real losses is the worst possible strategy in terms of your long-term financial success — and it’s completely avoidable.
Behavioral finance, the study of how psychology interacts with economics, has a term for why people panic-sell in a bear market: Loss aversion.
Psychologically, the pain of each dollar you lose hurts twice as much as the pleasure you feel when your accounts grow. So, it isn’t surprising that when people see negative returns, they want to sell. The mindset is: “I’ve already lost enough; I don’t want to lose more.” And when everyone’s panic-selling, it’s easy to second-guess yourself and wonder if this time really is different.
But savvy investors don’t take drastic actions based on what the market is doing today. Instead, they’re proactive about their long-term financial success. They focus on areas within their control.
It might feel like cashing out is a protective action, but trying to time the market requires you to guess right twice: When to sell and when to get back in the market. Instead of reacting to market movements that are completely out of your control, look at your own goals, and take steps to achieve them no matter what the market is doing.
Contribute to tax-advantaged accounts
It’s never a bad day to invest in your future wealth, especially if you get to save on taxes while doing so. Saving on a regular basis is another way to be proactive and automatically increase your return. This includes maxing out your tax-deferred retirement contributions, as well as contributing to after-tax accounts.
Both contribute to your future security. Some investors worry about buying at the top of the market. However, we cannot know what tomorrow will bring. Instead, try to allocate new savings in the most advantageous way by buying more undervalued areas, for example.
Keep investment costs low
Low costs are one of the most reliable predictors of future outperformance. Avoid investment commissions and transaction fees. If you or your advisor has access to institutional share classes, these are like bulk pricing for investments. The cheapest fund isn’t necessarily always the best one for your needs, but in today’s world, high-quality, low-cost funds are easy to locate.
Fund after-tax brokerage accounts
If you are maxing out your tax-deferred accounts, after-tax accounts are a great way to give yourself a different source of income in retirement. These are taxed annually, rather than all at once when you withdraw from a tax-deferred account.
Rebalance your portfolio
Ideally, you had a portfolio allocation that provided an appropriate level of risk/return for your needs. In good times and bad, make sure your portfolio has the mix of equities, fixed income, and alternatives for the long run.
If you didn’t rebalance at the end of 2019’s amazing bull run, for example, you would have experienced more losses in 2020’s bear market than if you had the proper allocation. It’s also important to rebalance to your long-term allocation in a bear market, and the added benefit is that you will typically be buying undervalued assets.
Have the right mindset
Another important factor within your control is your mindset. Taking a proactive and optimistic view of your investment future is far more beneficial than a scarcity mindset. Believe in your ability to build a plan to achieve your financial goals, and take the steps to make it a reality. And gain confidence in the fact that as a young and savvy investor, market corrections are some of the best opportunities for investing.
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