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How investors can sabotage their portfolio returns

Investor watching the change of stock market on

Investor watching the change of stock market on laptop Photo Credit: Getty Images/iStockphoto / SamuelBrownNG

Generally speaking, if the market is having a good year, your portfolio should be, too. If it’s not, you may want to point a finger toward yourself.

“The greatest risk is not the volatility of the market but the volatility of your own behavior,” says Daniel Crosby, a behavioral finance expert and founder of the investment management firm Nocturne Capital.

Crosby says psychologists have identified behaviors that can hurt the way we invest. Here are three that can drag down your returns, along with strategies to counteract them.

  • Overconfidence leads to overtrading

The vast majority of long-term investors shouldn’t trade frequently; those who do open themselves up not just to more risk but also to increased transaction fees and tax consequences, both of which can drag down returns.

“One of the reasons investors trade more than they should is that they think they know more than they do,” says Terrance Odean, a professor of finance at the University of California, Berkeley, who researches investor behavior. “They think they have more ability than they have, they end up trading more than they should, and that hurts their returns.”

  • We avoid losing at all costs

“We hate loss more than twice as much as we like comparably sized gains. Win $50 at a casino and it’s kind of ‘meh’ but lose $50 out of your wallet and it ruins your night,” Crosby says. Because of that, we may hold on to poor investments longer than we should to put off recognizing a loss, or flee to cash at any sign of a downturn.

To temper a fear of loss, set a long-term strategy and then try dollar-cost averaging, which involves dribbling a set amount of money into your investments at regular intervals. If you contribute to a 401(k) or make scheduled transfers into an individual retirement account, you already do this.

Investing according to a predetermined plan like this also takes emotion out of the game.

  • Blinders hamper our decision making

If you read only political websites that align with your views or block Facebook friends with opposing politics, you have a tendency to discount information that discredits your established beliefs.

But your money will benefit from balanced research.

If you can’t or don’t want to do that? Then you can turn to an index fund, work with a financial adviser or hold your accounts at an automated financial adviser — often called a robo-adviser — which is an online service that manages investments for you.

If you tend to keep an enthusiastic finger on the buy or sell button, stay away from individual stocks and their volatility, which can tempt you to make frequent trades. Instead, invest through index funds, which passively track a segment of the market. These funds are low-cost and well-diversified, and they frequently edge out even professional investors, like those at the helm of actively managed mutual funds.

If you tend to keep an enthusiastic finger on the buy or sell button, stay away from individual stocks and their volatility, which can tempt you to make frequent trades. Instead, invest through index funds, which passively track a segment of the market. These funds are low-cost and well-diversified, and they frequently edge out even professional investors, like those at the helm of actively managed mutual funds.

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