Don’t Let Your Emotions Rule

08/11/2011 7:30 am EST

Focus: MARKETS

Patrick McKeough

Editor, Successful Investor

During times of market turbulence like we’ve seen in the past days, it’s easy for investors to panic and deviate from well-thought-out plans, say Pat McKeough of TSI Network.

Here are three common investor mistakes we’ve noticed over the years:

Overanalyzing
During the recent market turbulence, the media has been full of economic statistics and analyses of government economic policies. You may feel tempted to try to figure out what the economy will do next, and invest accordingly.

But economic forecasting is hard enough. When you try to forecast market trends based on economic forecasts, you are virtually certain to fail.

As Peter Lynch (the world’s top mutual-fund manager from the 1970s through the early 1990s) wrote, if you spend 12 minutes a year worrying about the economy, you’ve wasted ten minutes.

Our general view is that if the US tries to tax its way out of the economic hole it’s in, it might relieve uncertainty about its debt, but it would also depress growth potential. That’s because higher taxes would further scare off business investment. We could fall into 1970s-style stagflation—high interest rates, weak growth, and high unemployment.

On the other hand, if the US decides to tackle its debt and deficit by cutting taxes and eliminating tax gimmicks and incentives, the market and economy could turn around quickly.

Investors should resist the urge to overanalyze and try to predict the future. If the situation continues to rapidly change, or if market turbulence increases, you could find yourself stuck with costly and unprofitable investments in your portfolio.

Refusing to Make Changes
The second easy mistake to make during times of market turbulence is to throw up your hands and refuse to consider changes in your portfolio.

Although you can’t predict the market or economy with any consistency, you can definitely choose which stocks are best suited to your portfolio, regardless of market turbulence.

You can also update your choices as new information becomes available. Even if we recommend all your stocks as buys in our investment newsletters, you still need to consider how appropriate your choices are for you as an individual and to your portfolio as a whole.

On the other hand, if your portfolio consists of too many stocks we see as "holds" or, worse, stocks that are merely "okay to hold," you run the risk of suffering steep losses, especially during periods of market turbulence.

Taking on Heavy Risk
Many investors do this in hopes of quickly reversing the losses they experience during market downturns. It’s a natural temptation in times of market turbulence like today.

Lately, you may have noticed a lot of ads for courses in online, short-term stock trading or foreign-exchange trading. The promoters are aiming their pitch at inexperienced investors who have suffered losses due to recent market volatility. These investors may be inclined to follow the example of desperate gamblers who bet their last few dollars on a handful of lottery tickets, or a long shot at the track or the casino.

That’s a particularly wasteful example to follow right now, when so many well-established stocks trade at low multiples of earnings and offer high dividend yields.

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