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Showing posts with label Investing Psychology. Show all posts
Showing posts with label Investing Psychology. Show all posts

Saturday, August 28, 2010

Realistic Investing Expectations

Over the long term stocks have provided us with great average return results. But this average return masks a great deal of volatility, because returns have fluctuated within a very wide band.

This extreme volatility is the chief risk of investing in stocks, but it is a risk that tends to recede from investors memories after a lengthy period of generally rising stock prices.

Those investors new to investing in stocks may underestimate the volatility of stocks because volatility has been muted in recent years.

Time greatly reduces, but certainly does not eliminate the volatility in returns from stocks. On the other hand, there is no guarantee that you will earn above average returns even if you hold stocks for two decades or more.

Investors who are relatively new to investing in stocks may benefit from some perspective about bear markets.

During the bear markets, Indexes declined an average of 25-35%. Although the average bear market lasted a little longer than 12 months, it took an average of almost 20 months for the Indexes to return to the levels achieved before the market downturns.

Although no one can reliably predict the timing of bear markets (or bull markets, for that matter), a prudent investor should understand the extent to which stock prices can decline and should be prepared to "ride out" these periods when they occur.

The big danger from bear markets is that investors will sell at or near the bottom of the downturn. Those who got out of stocks missed an extraordinary rebound in stock market performance.

Since risk is inescapable when investing in stocks, perhaps the greatest risk is that you will never invest in stocks because you can never be sure when is "the right time" to invest.

Uncertainty is a permanent feature of the investing landscape, and trying to discern the ideal time to invest is almost always a futile exercise.

Don't be swayed by market fluctuations or the opinions and predictions from market analysts and forecasters. Your investment strategy and expectations should all be based on your personal objectives, time horizon, risk tolerance and financial situation.

It should not be determined by the direction of the financial markets or the opinions of "The Experts!"

Friday, August 27, 2010

Investing Psychology

"I can calculate the motions of heavenly bodies... But not the madness of people!" - Isaac Newton (1642 - 1727)

Much of economic and financial theory is based on the notion that individuals act rationally and consider all available information in the decision-making process.

However, researchers have uncovered a surprisingly large amount of evidence that this is frequently not the case. Dozens of examples of irrational behavior and repeated errors in judgement have been documented in academic studies.

Peter Leonard Bernstein in his 1996 book "Against The Gods" states that the evidence "reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty."
A field known as "behavioral finance" has evolved that attempts to better understand and explain how emotions and cognitive errors influence investors and the decision-making process.

Many researchers believe that the study of psychology and other social sciences can shed considerable light on the efficiency of financial markets as well as explain many stock market anomalies, market bubbles, and crashes.

Investing can be an emotional process unless you understand what you are investing in, what you're trying to accomplish and understand a few basic facts and statistics.

To make educated decisions and to avoid the emotional ones always try to pursue the rational and logical side of investing.

Remember, facts and statistics are the basis for good and profitable investing.

The stock market is not gambling and the reason is simple, gambling is never included in companies' annual reports.