9 Investing Traps That Can Sink Your Portfolio
NEW YORK (MainStreet) Your brain is hard-wired to hijack your investments. In an advisory to investors issued by the Securities and Exchange Commission and based on report issued by the Federal Research Division of the Library of Congress, nine investing behaviors are identified that often contribute to below average portfolio profits. Avoid these natural tendencies and you will likely reduce risk and enhance the return of your investments.
1. Huddled between monitors, tracking and trading the market minute-by-minute is a failed strategy, according to the report. Active traders attempt to profit from small changes in the market which "generally results in the underperformance of an investor's portfolio," the advisory says.
2. When to buy and when to sell? Deciding how long to hold an investment is a strategy many investors find hard to master. The tendency to hold on to losing investments too long and sell winning investments too soon is known as the disposition effect. The timing of when to sell winners is particularly vexing. The report notes that "[i]n the months following the sale of winning investments, these investments often continue to outperform the losing investments still held in the investor's portfolio."
3. Mutual funds were designed to simplify the process of investing for the everyman. However, investors tend to focus on a fund's past performance and often fail to consider fees. Expense ratios, transaction costs, and load fees can have a significant and negative -- impact on returns.4. Buying shares in the company we work for, or holding a portfolio full of American blue chip stocks, is an example of "familiarity bias." Purchasing investments based on where you live, work or how you play can cause a portfolio to be inadequately diversified, increasing risk and causing missed opportunities in geographical or industrial areas in which you are less familiar. "Glamour investments" high profile and popular investments - can also foil a portfolio's performance. 5. Trading on market movements based on emotion is another investor behavior to avoid. Market "mania" or a "bubble" reflects an enthusiasm for a sector or investment that may have little basis in fact. Prices rise as the fever mounts. A collapse or "panic" can occur with the same crowd-based catalyst, triggering a wide-scale sell-off without reason. 6. Riding a wave of trading is known as "momentum investing": hoping to cash-in on prevailing trends, a "momentum investor believes that large increases in the price of an investment will be followed by additional gains and vice versa for declining values," according to the SEC advisory based on the Library of Congress report. 7. Faced with a menu of investment options and buying a little bit of everything is termed "naive diversification:" While it may not result in lower returns, it can mean higher portfolio risk. 8. A knee-jerk reaction to good or bad news that causes an investor to buy or sell a holding is "noise trading." Rather than basing trading decisions on fundamental data that can actually impact an investment's value, "noise" traders often suffer from poor timing and tend to follow trends at their portfolio's expense. 9. Holding too small a number of investments or having a portfolio overly concentrated in one type of investment can lead to "inadequate diversification." It can often lead to taking on an increased amount of risk. The Library of Congress initially released the report on investor behavior in 2010. --Written by Hal M. Bundrick for MainStreet
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