At one point or another, even the most seasoned and experienced investors have made bad investment decisions.
Whether you heard about a hot stock or crypto and “bought the top” before a big plunge… or you held on to a big gain too long and watched your profits wither away… Fear likely played a role in your decision.
You see, the emotional roller coaster ride shakes many investors out of the market. They buy at tops and sell at bottoms…
This is the main reason the average investor severely underperforms the market. They have incredibly bad timing.
In fact, one study shows that profiting from the market is less about what you buy and more about when you buy and how long you hold.
So Easy a Baby Could Do It
The study – called “Selling Fast and Buying Slow” and authored by professors from the University of Chicago and Massachusetts Institute of Technology – analyzed the historical performance of 783 portfolios owned by both wealthy and institutional investors (like pension and hedge funds).
To judge the performance of these Wall Street elites, the study compared their results to a portfolio of alternatives randomly selected by a baby.
So no investment knowledge or even the ability to read was needed… just a baby randomly pointing at a screen…
And the results were pretty revealing.
When it came to buying stocks, the pros outperformed the babies by about 1.2 percentage points.
But when it came to selling stocks – and actually booking profits or losses – it was a completely different story.
The babies’ random selections outperformed the Wall Street elites by 0.8 percentage points.
(And since Wall Street greatly outperforms Main Street… The babies would likely outperform the average investor, too.)
Now, we’re not saying that all your investment decisions should be completely random… But the takeaway here is pretty clear.
While analysis and research definitely lead to better buying decisions… Removing emotion and bias from your selling decisions leads to better results.
Unfortunately, human nature means that emotion often overrides even our most rational decisions… And when the market is volatile and prices are falling, stepping back and thinking rationally can be the hardest thing to do.
That’s why we put together some rules to help you become a more rational investor… and protect your portfolio whether the markets are up or down.
Three Rules for Rational Investing
Whether you’re eying a new investment or unsure about cashing out your gains, these three rules will help you make more rational investing decisions…
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Diversify your assets.
The secret to building wealth – and keeping it – is diversification.
We recommend a mix of stocks, bonds, cash, real estate, collectibles, cryptos, and other alternatives.
Not only does diversification lead to better returns, it also lowers risk. Numerous studies show that asset allocation accounts for 90%-plus of your investment returns.
Diversification also means your losses are less painful since they’re offset by your winners… So you’ll be less likely to give in to fear and sell at the wrong time.
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Tune out short-term forecasts.
The market’s short-term direction is unknowable. No one has a crystal ball. Even experts get it wrong more often than right.
Whether it’s stocks or crypto, unless you’re a day trader, daily volatility shouldn’t bother you. So don’t get sidetracked by the noise. Just focus on the big picture.
If the long-term fundamentals that led you to buy are still intact, then you don’t need to be afraid of temporary price dips or bumps in the road.
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Have a risk management plan.
Before you can grow your wealth, you need to protect the wealth you have. The best way to do that is with position sizing. Adding a stop-loss policy can help, too.
Position sizing refers to the size of a position within your portfolio (or the maximum dollar amount you’re going to trade). Our simple rule of thumb is: If an investment gets stopped out of your portfolio, your maximum loss should be no more than 2.5–5% of your portfolio’s value.
If you know your downside is capped, then you can sleep well at night. This way, you won’t panic-sell at the worst time.
Palm Beach Research Group