Most Irrational Investing Missteps
NEW YORK ( MainStreet) Eliminating emotions when making investments and replacing it with logic by evaluating the fundamentals in a market is a daunting task for many investors.
Investment decisions are often dominated by fear, greed or by only examining short-term outcomes, experts said.
Investors are buying and selling their stocks, bonds and other funds too often instead of looking at other factors such as whether the company is growing its business, producing cash flow and creating competitive strategies, said Kyle Mowery, managing partner and portfolio manager at GrizzlyRock Capital, a Chicago alternative asset management firm.
"We focus on what is driving the performance of the stocks versus whether it is up or down," he said. "We believe in fundamental research and that is the right way to invest."
Many investors are focused only on short term gains or losses instead of long term yields, he said.
"The markets are made up of people and people are not rational," Mowery said. "There are irrationalities in the stock market, and we look to capitalize on those. People have a tendency to overemphasize information that happened yesterday that is more salient than information that happened a year ago."
Other investors focus on how the market is reacting to new information, especially geopolitical news.
"Markets tend to overreact to new information," he said. "It is hard to know if it is cyclical in nature or secular or permanent. There is a shorter term bias in the market. It can be exploited."
A better approach is to balance the risks and rewards of the investments in your portfolio, Mowery said.
"Investors should be looking for a rational, balanced approach that maximizes all of your investments over time," he said. "You want to buy your stocks like your groceries when they are on sale."
Divesting a mutual fund only because its yield has declined recently is not the right approach, Mowery said. Instead, investors should purchase one that produces better fundamentals.
"Investors should wait for it to come back up or rebalance their portfolio by taking some money out of a fund that is doing well and putting it into something that balances your risk so you can have a smoother return stream," he said.
Some investors rely on anchoring when making their investment decisions by basing it on "events or values with which they are familiar, even though they may have no bearing on the actual value," said Kimberly Clouse, private client advocate at Covestor, a registered investment advisor.
People who follow this strategy are using irrelevant information as a reference point and often increase their risk instead of their reward. One common example is when an investor buys a stock at $100 per share, but learns that the financial situation at the company deteriorates for a significant reason. The stock price then falls to $80, but the investor still hangs onto the stock hoping that it will regain its value and rise back to $100 so he can break even at the price at which it was purchased, she said.