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How to avoid the pitfalls of the common investor in 5 easy steps

by Jim Sloan

In 2010, the average equity investor earned 13.6 percent, just a little behind the 15.1 percent increase in the S&P 500. Unfortunately, that kind of return is often the exception rather than the rule. Average investors earned 3.8 percent annually over the last 20 years, while the S&P was at 9.1 percent, according to financial services market research firm Dalbar Inc.

Why do investors perform so poorly? The Dalbar study found there are "psychological factors" that hamper the average investor, but that there are also some fairly easy methods you can use to avoid them. Here, then, are the top 5 ways you can keep your investments on pace with the market:

1. Recognize and fight your aversion to losses.

Losses have a much greater psychological impact on us that gains, and our fear of losing money can lead us to do unfortunate things, such as selling a stock early and missing out on the long-term gains. A September 2010 study from Charles Schwab found that well-advised investors have more discipline and were able to stay the course between July 2008 and February 2009 and were able to benefit when the stock market rebounded.

2. Avoid the 'status quo' bias.

According to CNNMoney, we are inclined to do nothing when we should be doing something. An example is how more than 35 percent of American workers weren't putting anything into their retirement savings accounts during the recession two years ago. So stay engaged in the finances. Look for the best cd rates and the best savings account.

3. Don't follow the herd.

This is a common phenomenon. People don't want to think they are missing out on something big, so they do what everyone else is doing, like making investments in real estate in 2005 or gobbling up tech stocks in the late 1990s. Sometimes you just have to do what makes sense, even if no one else has caught on yet.

4. Stick to the long view.

It's hard to see past what's right in front of you, particularly when your stocks are taking a tumble. Instead of obsessing about the best savings accounts or money market rates, remember that interest rates and the stock market will recover, and spoils will go to those who didn't commit kneejerk reactions.

5. Narrow your choices.

According to CNNMoney, many people fail to adequately invest for their retirement because they are overwhelmed by the number of choices available to them. Behavioral analysts call it choice paralysis. So instead of trying to be an expert on all the different types of investments out there, focus on a few and become very familiar with them.

Investments require your attention

Most of us aren't done in by picking the wrong stocks but by monkeying with our investments when they should be left alone and doing nothing when we should be doing something, like putting money in a 401(k) so we can take advantage of our employer's match.

Need a little nudge? According to CNNMoney, some researchers have found that altering a person's photo to show what they will look like when they are 70 makes them much more likely to start saving. You may not have that much skill with photography software, but if you can use your imagination and picture yourself at 70 you might find that you're more willing to put more money away.


Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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