What investing behaviors undermine investment performance?

Following nine investing behaviors that can undermine investment performance.

1. Active Trading: An investor using an active trading investment strategy engages in regular, ongoing buying and selling of investments. This kind of investor purchases investments and continuously monitors their activities in order to take advantage of profitable conditions in the market. Active trading generally results in the underperformance of an investor’s portfolio.
   

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2. Disposition Effect: The disposition effect is the tendency of an investor to hold on to losing investments too long and sell winning investments too soon.  In the months following the sale of winning investments, these investments often continue to outperform the losing investments still held in the investor’s portfolio.

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   Focusing on Past Performance of Mutual Funds and Ignoring Fees:  When deciding to purchase shares in a mutual fund, some investors focus primarily on the mutual fund’s past annualized returns and tend to disregard the fund’s expense ratios, and transaction costs, etc. despite the harm these costs and fees can do to their investment returns.

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   Familiarity Bias:  Familiarity bias refers to the tendency of an investor to favor investments from the investor’s own country, region, state, or company.  Familiarity bias also includes an investor’s preference for “glamour investments;” that is, well-known and/or popular investments. Familiarity bias may cause an investor’s portfolio to be inadequately diversified, which can increase the portfolio’s risk exposure.

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   Manias and Panics:  Financial “mania” or a “bubble” is the rapid rise in the price of an investment, reflecting a high degree of collective enthusiasm or exuberance regarding the investment’s prospects. This rapid rise is usually followed by a contraction in the investment’s price. The contraction or “panic” occurs when there is wide-scale selling of the investment that causes a sharp decline in the investment’s price. Be aware of these.

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   Momentum Investing: An investor using a momentum investing strategy seeks to capitalize on the continuance of existing trends in the market. 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.

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   Naïve Diversification: Naïve diversification occurs when an investor, given a number of investment options, chooses to invest equally in all of these options.  While this strategy may not necessarily result in diminished performance, it may increase the risk exposure of an investor’s portfolio depending upon the risk level of each investment option.

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   Noise Trading: Noise trading occurs when an investor makes a decision to buy or sell an investment without the use of fundamental data (that is, economic, financial, and other qualitative or quantitative data that can affect the value of the investment). Noise traders generally have poor timing, follow trends, and overreact to good and bad news in the market.

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   Inadequate Diversification: Inadequate diversification occurs when an investor’s portfolio is too concentrated on a particular type of investment.  Inadequate diversification increases the risk exposure of an investor’s portfolio.

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Disclaimer:
Investors should seek the advice of their financial advisor prior to making any investment decision based on this report or for any necessary explanation of its contents. Future estimates mentioned herein are personal opinions and views of the author. This post is not a recommendation to buy or hold or sell securities. Investments are subject to market risks. Please read all investment-related documents carefully.

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