You’ve heard the adage, “Buy low, sell high.” Unfortunately, many investors do just the opposite when they see the market dropping. Shaken by downswings, they cash out and miss any subsequent gains.
Dalbar’s annual Quantitative Analysis of Investor Behavior consistently reports that investors’ returns lag those of the market. The single largest contributor to this gap over time is psychology, including behavioral biases like loss aversion, which can lead to poor investment decision-making. Those who study behavioral finance look for the reasons behind investors’ irrational financial decisions.
An investor who hesitates to buy as the market climbs may finally decide to get in as it reaches its peak. An investor who panics when the market drops may flee just as it reaches its lowest point.
This chart shows how an investor trying to time the market can get it all wrong. During periods when equity returns have been relatively high, people have tended to flock to the market when prices were at their highest. But when equity returns have declined, many have sold their holdings and left the market at a time when stock values have been most attractive.
You may feel that doing something — anything — during a downturn is better than doing nothing. Inaction might seem counterintuitive, but simply staying invested could be the better choice.
These tips can help you avoid making rash decisions based on emotions:
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