Fear and greed can undermine DIY investment strategy

There’s a lot of advice online on how to pick stocks on your own. However, the practice of learning online and going at it alone can be unwise for investors who try to manage their own portfolios.

China Stringer Network/Reuters/File
An investor walks past in front of an electronic board showing stock information at a brokerage house in Beijing, China, November 17, 2015.

By Blake Fambrough

Learn more about Blake on NerdWallet’s Ask an Advisor.

The internet has built a belief that we can figure out everything on our own with just a few clicks. This offers a phenomenal advantage in many cases, bringing an almost unlimited amount of information and knowledge to our computer screens.

There’s a lot of advice on how to pick stocks on your own — a Google search for “do-it-yourself investing” generates more than 41 million results. However, the practice of learning online and going it alone can be unwise for investors who try to manage their own portfolios. Why? Blame human nature.

Most of us are wired incorrectly when it comes to managing our own money. Too often, we allow greed and fear to drive our decisions, instead of following a sound investment strategy and allowing the market’s ups and downs to sort themselves out. The results can be financially catastrophic.

The dot-com greed cycle

The dot-com boom of the late 1990s is a great example. From 1997 to 2000, internet-related stocks hit records and investors got greedy. Believing that prices would keep rising forever, people poured into the market to buy stocks at prices that were not justifiable. Alan Greenspan, then the Federal Reserve chairman, called this mindset “irrational exuberance.”

This buying spree caused stocks to be extremely overpriced and created a market bubble that burst in mid-2000, dragging down major indexes through 2002. Investors rode the losses all the way down.

Fear can be equally harmful to the growth of your investment portfolio. For example, fear caused many investors to keep their money in cash during the U.S. bear market of 2007-09 when the Standard & Poor’s 500 index lost approximately 50%. The Dow Jones industrial average also had lost 20% of its value by June 2008. In other words, the pain during those years got so severe that investors ran for cover, keeping their money in cash, or investments with no earning potential. As the market recovered, they missed out on the chance to recoup their losses.

The key to avoiding this situation is to have an investment management system that is based on time-tested evidence and analysis. For example, tactical portfolio management takes emotions out of the process to minimize risk and grow your investment portfolio over time. This includes having a diversification strategy that captures the upside of various asset classes, and creating an alternative to “buy-and-hold” investment strategies, which are not always conducive to volatile markets. By using such strategies, your portfolio can be positioned to grow in a bear market (when prices are falling) or a bull market (when prices are rising).

Working with a financial professional

Another way to keep greed and fear from hindering your investment strategy is by hiring a financial advisor. A 2014 research paper by mutual fund company Vanguard, which caters to “do-it-yourself” investors, found that clients working with advisors using Vanguard’s wealth management framework saw net returns increase by about 3% (though the study noted that the increase was intermittent rather than annual).

When determining what type of financial professional to work with, seek an independent registered investment advisor who is not affiliated with a broker/dealer. Such advisors are legally required to uphold the fiduciary standard, which means they are obligated to put their client’s interests ahead of their own when offering investment advice or services. They also must practice transparency to avoid any client confusion or conflicts of interest. Registered investment advisors who are also certified financial planners must uphold the CFP Board of Standards professional conduct and code of ethics.

By setting up an investment strategy, preferably with the help of a trained financial advisor, you stand a better chance of avoiding the greed and fear that sinks so many portfolios.

Blake Fambrough is a certified financial planner and financial advisor with Dubots Capital Management in Temecula, California.

This story originally appeared on NerdWallet.

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