3 Steps to Avoid Investing Mistakes

It seems everywhere you look these days in the financial media, the drumbeat for an impending market correction, or even recession, grows louder. It’s natural, I suppose, considering that the current bull market for equities is entering its 8th year, making it one of the longest in history. The truth is that some kind of correction is coming, and a recession too, for that matter. The problem is that no one really knows when, or how deep, and it’s usually triggered by something no one saw coming.

Because of this, we, as financial advisors, have a duty to be clear with our clients about the potential for declines, just as we do in the opposite case: to play the cheerleader in the midst of market downturns, when morale is low. The idea, in both instances, is to help clients avoid making emotional decisions based on short-term market conditions, which could do real damage to their long-term financial goals. (For more, see: How to Avoid Common Investing Problems.)

I was reading an article by Peter Bregman in the Harvard Business Review recently called, “Quash Your Bad Habits by Knowing What Triggers Them,” and it struck me that many of the same principles apply to investing. I’ve often wondered why some clients are able to so easily tune out the negativity and take market downturns in stride, while others seem to feel the weight of every 100 points on the Dow so acutely. But even more importantly, why some of those clients cannot resist the urge to do something, even as they understand in their more serene moments, that these are exactly the types of urges that can lead to extremely negative outcomes in the long run.

A Three Step Process

In his article, Mr. Bregman discusses the connection between counterproductive habits and the destructive consequences they have on interactions with others. His conclusion is that while habits are extremely hard to change, they can be changed and he offers some alternatives to those habits.

He outlines a three step process that I believe translates to investing as well.

  1. A moment of awareness.
  2. The ability to resist urges.
  3. A replacement behavior.

Mr. Bregman points out that we cannot hope to change a habit that we are not aware of. The first step towards addressing a problem is admitting that you have one, advice most of us have heard at some point in our lives. This is why it is vital to understand if you are the kind of person prone to making knee-jerk reactions in the face of market stress. The fact is that many people who seek the help of financial advisors do so because they have made mistakes in the past. And if that is the case, it is important to be honest with yourself about that to avoid the same mistakes going forward. (For more, see: How to Separate Emotions from Investing Decisions.)

Once you’ve done that, the key is to understand what triggers the reaction because in order to be effective, the "moment of awareness” must precede the reaction. Is it seeing the declines on the monthly statement, or hearing the pundits in the media that sets you off? Identifying the triggers, allows you to try to limit your exposure to them or even more importantly, to understand that if you can pause for a moment and suppress the temptations they cause, you have a much better chance of avoiding the reaction.

It's one thing to have the urge to make a reactionary decision, but it’s another to actually do it. We’re faced with this dilemma all of the time in our regular lives. Just because we have the urge to scream at the person who cut us off on the road doesn’t mean we do it. Whether it’s because we know it won’t get us anywhere, or understand that getting into a road rage incident could get out of hand quickly, we resist urges all the time. Which is why the second step is about understanding that it is ok to feel the impulse to ‘do something’, so long as we realize that retaining the ability to resist that impulse will ultimately benefit us.

For some of us though, resisting the urge to act simply because it is in our best interest can be difficult. Creating a replacement behavior can often help. Financial advisors spend countless hours coaching clients to try not to focus so much on the day to day or even month to month fluctuations of the markets. The markets are going to do what the markets do. Instead, the point is to try to focus on goals - where are we trying to go and whether we are doing everything we can to get there. By widening our perspective during times of volatility, we can often reduce the angst we feel when focusing on short-term performance.

The Biggest Risks

There are no magic investments that will never go down. The fact is that to achieve the kinds of returns most people need to realize their financial goals, they will need to be exposed to markets and their volatility. But what we know is that the biggest risks to attaining those returns is not that the markets will go up and down, because they will. The biggest risk, for most, is their behavior during times of volatility of making knee-jerk reactions that can derail a good long-term strategy. If we can admit that we suffer from some of those counterproductive habits and identify the triggers that cause them, we stand a much better chance of sticking to our strategy and ultimately achieving successful outcomes in the long run. (For more, see: The Financial Markets: When Fear and Greed Take Over.)