6/15/2011 11:55 AM ET.
By U.S. News & World Report
7 keys to mistake-free investing
In a survey, wealthy investors acknowledge a tendency to let emotions drive investment decisions. Plus: Why women are better at long-term investing.
Overcoming emotional and personality-driven investing mistakes is widely recommended but hard to achieve. One of the keys to success is recognizing that a problem exists and devising mechanisms to control or limit bad decisions.
According to a recent global survey by Barclays Wealth, a large percentage of wealthy investors not only realize their tendency to make decisions based on emotions but would welcome help in dealing with the problem.
The report, "Risk and Rules: The Role of Control in Financial Decision Making," also revealed an extensive set of control strategies that people use to limit bad decisions. The most successful at doing so happen to be the wealthiest, although there could be other factors contributing to high-wealth achievement.
Psychology of successful investors
Perhaps the most interesting finding of the research involved what the report called "the trading paradox," said Greg Davies, who directs Barclays Wealth's work in behavioral and quantitative finance. Many wealthy investors believe they need to trade frequently to maximize investment gains. At the same time, wealthy investors were most likely to believe their overall returns suffered because they traded too much.
"Almost 50% of traders who believe you have to trade often to do well think they overdo it," the report said.
"Failures of rationality," as the report called them, were seen in four types of investment decisions:
1. Failing to see the big picture. Considering decisions in isolation and not including their impact on an entire portfolio was cited as a problem.
Consequence: Investing too much in a single asset class, industry or geographic market because you know a lot about it and are comfortable with such decisions.
2. Using a short-term decision horizon. Ignoring the appropriate goal of long-term wealth accumulation in favor of short-term returns hindered investors.
Consequence: Statistically, losses are more likely in the short run. Because people are twice as sensitive to losses as to gains -- a behavioral phenomenon known as "myopic loss aversion" -- their willingness to take short-term risks is too low and they often make the wrong investment decisions.
3. Buying high and selling low. Investors tend to do what's comfortable amid bullish or bearish market conditions.
Consequence: Buying when markets are high or selling when markets are low is a risky strategy that fails to take advantage of market opportunities. A buy-and-hold strategy is superior.
4. Trading too frequently. Multiple emotional and personality traits produce an irrational bias toward action.
Consequence: Investment costs are higher, and the frequency of other poor decisions is increased.
"This lack of control over our emotions is not an abstract problem," the Barclays study said, and "it can have tangible, detrimental effects on both investor satisfaction and performance."
Over the past two decades, the average equity investor earned 3.8% a year, while the Standard & Poor's 500 Index ($INX) returned 9.1% annually, according to a recent Dalbar study into investor behavior.
The report also found substantial improvement in investment decisions as people aged. Older investors were much less likely to trade too often, try to time the market or base investments on short-term considerations.
They were also more satisfied with their financial situation.
Barclays Wealth also found that women are better long-term investors than men, who tend to take more risks and are more likely to favor frequent trading and efforts to time the market.
"Women tend to have lower composure and a greater desire for financial self-control, which is associated with a desire to use self-control strategies," the report said.
"Women are also more likely to believe that these strategies are effective." As a consequence, women tended to trade less and earn higher returns over time.
Barclays Wealth sponsored surveys of more than 2,000 people from 20 countries who had at least $1.5 million in investment assets, including 200 with at least $15 million. These investors may not have known the details of their emotional flaws as documented by behavioral economists. But they were aware that they were prone to bad decisions and were open to getting help.
The report identified seven self-control strategies to help people counter their tendencies to make bad decisions. The use of these strategies was not limited to investments and often included other behaviors, such as big-ticket purchases or dieting and exercise.
Here are the seven strategies and their application to financial decisions:
1. Limit the options. Purchase illiquid investments to avoid the urge to sell investments when the market is falling.
2. Avoidance. Avoid information about how the market or portfolio is performing in order to stick to a long-term investment strategy.
3. Rules. Establish and use rules to help make better financial decisions, such as spend only out of income and never out of capital.
4. Deadlines. Set financial deadlines. For example, aim to save a certain amount of money by the end of the year.
5. Cool off. Wait a few days after making a big financial decision before executing it.
6. Delegation. Delegate financial decisions to others, such as allowing an investment adviser to manage your portfolio.
7. Other people. Use other people to help reach financial goals. An example would be meeting with a financial adviser to make and execute a financial plan.
This article was reported by Philip Moeller for U.S. News & World Report.
By U.S. News & World Report
7 keys to mistake-free investing
In a survey, wealthy investors acknowledge a tendency to let emotions drive investment decisions. Plus: Why women are better at long-term investing.
Overcoming emotional and personality-driven investing mistakes is widely recommended but hard to achieve. One of the keys to success is recognizing that a problem exists and devising mechanisms to control or limit bad decisions.
According to a recent global survey by Barclays Wealth, a large percentage of wealthy investors not only realize their tendency to make decisions based on emotions but would welcome help in dealing with the problem.
The report, "Risk and Rules: The Role of Control in Financial Decision Making," also revealed an extensive set of control strategies that people use to limit bad decisions. The most successful at doing so happen to be the wealthiest, although there could be other factors contributing to high-wealth achievement.
Psychology of successful investors
Perhaps the most interesting finding of the research involved what the report called "the trading paradox," said Greg Davies, who directs Barclays Wealth's work in behavioral and quantitative finance. Many wealthy investors believe they need to trade frequently to maximize investment gains. At the same time, wealthy investors were most likely to believe their overall returns suffered because they traded too much.
"Almost 50% of traders who believe you have to trade often to do well think they overdo it," the report said.
"Failures of rationality," as the report called them, were seen in four types of investment decisions:
1. Failing to see the big picture. Considering decisions in isolation and not including their impact on an entire portfolio was cited as a problem.
Consequence: Investing too much in a single asset class, industry or geographic market because you know a lot about it and are comfortable with such decisions.
2. Using a short-term decision horizon. Ignoring the appropriate goal of long-term wealth accumulation in favor of short-term returns hindered investors.
Consequence: Statistically, losses are more likely in the short run. Because people are twice as sensitive to losses as to gains -- a behavioral phenomenon known as "myopic loss aversion" -- their willingness to take short-term risks is too low and they often make the wrong investment decisions.
3. Buying high and selling low. Investors tend to do what's comfortable amid bullish or bearish market conditions.
Consequence: Buying when markets are high or selling when markets are low is a risky strategy that fails to take advantage of market opportunities. A buy-and-hold strategy is superior.
4. Trading too frequently. Multiple emotional and personality traits produce an irrational bias toward action.
Consequence: Investment costs are higher, and the frequency of other poor decisions is increased.
"This lack of control over our emotions is not an abstract problem," the Barclays study said, and "it can have tangible, detrimental effects on both investor satisfaction and performance."
Over the past two decades, the average equity investor earned 3.8% a year, while the Standard & Poor's 500 Index ($INX) returned 9.1% annually, according to a recent Dalbar study into investor behavior.
The report also found substantial improvement in investment decisions as people aged. Older investors were much less likely to trade too often, try to time the market or base investments on short-term considerations.
They were also more satisfied with their financial situation.
Barclays Wealth also found that women are better long-term investors than men, who tend to take more risks and are more likely to favor frequent trading and efforts to time the market.
"Women tend to have lower composure and a greater desire for financial self-control, which is associated with a desire to use self-control strategies," the report said.
"Women are also more likely to believe that these strategies are effective." As a consequence, women tended to trade less and earn higher returns over time.
Barclays Wealth sponsored surveys of more than 2,000 people from 20 countries who had at least $1.5 million in investment assets, including 200 with at least $15 million. These investors may not have known the details of their emotional flaws as documented by behavioral economists. But they were aware that they were prone to bad decisions and were open to getting help.
The report identified seven self-control strategies to help people counter their tendencies to make bad decisions. The use of these strategies was not limited to investments and often included other behaviors, such as big-ticket purchases or dieting and exercise.
Here are the seven strategies and their application to financial decisions:
1. Limit the options. Purchase illiquid investments to avoid the urge to sell investments when the market is falling.
2. Avoidance. Avoid information about how the market or portfolio is performing in order to stick to a long-term investment strategy.
3. Rules. Establish and use rules to help make better financial decisions, such as spend only out of income and never out of capital.
4. Deadlines. Set financial deadlines. For example, aim to save a certain amount of money by the end of the year.
5. Cool off. Wait a few days after making a big financial decision before executing it.
6. Delegation. Delegate financial decisions to others, such as allowing an investment adviser to manage your portfolio.
7. Other people. Use other people to help reach financial goals. An example would be meeting with a financial adviser to make and execute a financial plan.
This article was reported by Philip Moeller for U.S. News & World Report.
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