CHICAGO (Reuters) – Is the Dow’s movement above 15,000 or the record close of the S&P 500 Index last week a buy signal? They may not mean anything, but most market watchers believe the rise is talismanic.
Despite the lure of recent market gains, there’s often no pattern to investment results. To avoid seeing patterns where there may be none – and acting irrationally – we often need to short-circuit our instincts and think counter-intuitively.
A go-slow approach that avoids trading on market timing can often avert losses. Here are some behavioral biases and ways to prevent bad decisions:
1. Don’t time jumps in and out of the market.
Trading decisions typically are expensive and eat into your total return.
A study released late last year by the Gerstein Fisher research center found that the S&P 500 posted a 6.66 percent annualized return from January 1, 1996, through December 31, 2010. After trading, inflation, fund expenses and taxes, however, individuals reaped a miserable 1 percent return. Investors paid a steep penalty for market timing.
2. Buy and hold works.
We tend to be overconfident in our ability to predict the future.
Let’s say you held a basket of small-company stocks from 1993 through last year. You would have reaped an 11 percent compound annual return, according to Ibbotson Associates. If you were in large stocks, your gain would have been about 8 percent on average annually if you held your position for 20 years through 2011, according to Dalbar, a Boston-based financial research firm.