How To Avoid Common Investor Mistakes
People often make financial decisions based on impulses and market shifts—here’s another way to do it.
Investing mistakes are often rooted in our natural reactions. Let’s face it: We don’t always react the right way to information. And when enough investors have poor reactions, it can affect the entire market.
Behavioral finance is a field of study that looks at how psychology affects financial decisions. It helps us understand why investors make common mistakes, so it’s easier to avoid them. But don’t worry—it doesn’t have to be complicated. Some of the most important lessons from this field are surprisingly simple.
Try to invest with a goal in mind
Investing can be one of the smartest financial decisions you can make. But a lot of investors start without knowing what they’re working toward—and that’s, well, less smart. When you don’t know why you’re building a financial portfolio, it’s a lot harder to know how to structure your investments.
Instead, start with why. What do you want to be able to spend money on in the future? When are you going to use that money? These aren’t just stocks and bonds. Your investment is a future downpayment on a house. Your dream car. Retirement. College. Real things and experiences you want to be able to afford.
Having a goal can help take the guesswork out of investing. You can calculate exactly how much you need to invest based on the range of potential outcomes. It’s also easier to decide where to put your investments. Retiring in 40 years? You might consider taking on more risk and allocating more in stocks. Hitting your goal next year? Play it safe.
When you know how much you need to invest, break it into monthly chunks and automate your deposits. With recurring deposits, you're basically “paying yourself first” before worrying about other expenses. That way, you won’t talk yourself into skipping a month. (Which turns into two months, then three, and—oops, it’s been a year.)
Focus on the long-term
When you invest, you’ll likely have short-term losses here and there. It’s inevitable. And most times, it can be a mistake to make adjustments when your portfolio loses value. You can’t predict tomorrow’s performance based on yesterday’s.
Even during the last ten years of steady growth, investors had to endure short-term losses at some point every year. Given enough time, the market trends upwards. And investments that perform poorly one day can easily make up for it the next.
But that’s not what people tend to think about when they see their portfolio lose 15% of its value. They can panic. They make sweeping changes, reinvesting in funds and stocks that had short-term gains. And those big emotional decisions can do more harm than good.
Investing is about long-term gains. Short-term losses are simply part of the process, so don’t panic every time there’s a loss.
Watch out for “lifestyle creep”
You don’t have to live frugally to be a successful investor. It helps, but the bigger issue is making sure that as your income increases, you stay in control of your lifestyle and spending. Most people see small pay increases over the course of their lives. 3% here. 8% there. When your regular spending increases with your income, it’s known as “lifestyle creep.” It can easily get in the way of saving enough to achieve your goals.
If you have a lower income, it makes sense that more of your money goes toward basic necessities. But lifestyle creep happens when you gradually spend more on things you don’t need. Entertainment. Hobbies. Take out.
Every time you increase your regular spending, your lifestyle costs more to maintain. You’ll likely need to save more for retirement. Your emergency fund may need to grow, too.
Lifestyle creep is an even bigger problem if you started investing with the expectation that you’d invest more later. Some people feel intimidated by their goals, so they plan to increase the amount they invest when they start making more money. That’s fine—as long as you actually do it.
Temporary increases in spending are OK. But as you make more money, don’t let a more extravagant lifestyle sabotage your goals.
Five ways Betterment helps improve your investing behavior
We help you see the big picture
Our non-traditional portfolio presentation helps discourage investors from focusing on daily market movements. We show the constituents of your portfolio as the parts of a whole, but never the return of each individual component. This helps reduce the temptation to constantly adjust your allocation and make your portfolio less diverse.
We encourage optimized deposit settings
Setting up recurring deposits for the day after you get paid can set you up for success in a number of ways. First, it removes the constant temptation to pocket the cash instead. Second, it gives your paycheck just enough time to settle without letting that cash idle for long. And third, it can help rebalance your portfolio more tax-efficiently.
We keep the focus on the future
Our design helps you focus on decisions that matter—the ones about the future. Our minds assign a disproportionate significance to daily volatility, but it rarely impacts our long-term outlook. So instead of emphasizing daily market movements, we simply keep you updated on whether you’re on-track to reach your goals.
We give you the information you need
Conventional wisdom says advisors should proactively contact their customers when the market drops. This can create undue anxiety, and it can even prompt negative behaviors, such as making large unnecessary withdrawals. Instead, we carefully target our emails and in-app notifications, using active engagement as a filter.
We show you the potential tax impact of transactions
We display the estimated tax impact of an allocation change or withdrawal before you finalize the transaction. This estimate is not only useful information in its own right, but it’s also intended to help drive better investing behavior by reducing the number of unnecessary changes.