Investors are often their own worst enemies. That’s because they sometimes allow their emotions to get the best of them when it comes to making financial decisions. They hear their neighbors at cocktail parties talk about hot stocks they own and wonder why they can’t hit it big. Others are more jittery, selling their shares the moment they dip in value without understanding what’s causing the decline. For socially responsible investors, the paranoia can be heightened by a rumor of scandal or corporate misbehavior among the companies they hold.
Step one to good investing is to understand yourself and how comfortable you are when putting your savings at risk. That’s what you’re doing when you buy stocks or mutual funds. There is the potential that your investment will increase in value, but there is also the risk that it can be worth less.
Before you jump in to the stock market ask yourself a few questions:
Can I afford to lose my investment?
There’s an old joke on Wall Street about people who buy a big block of an inexpensive stock. “It’s only $10 per share,” says the investor. “How much can I lose?” Answer, “All of it.”
If you need your money to pay your bills, you shouldn’t use it to buy stocks. If you need your money for a near term expense, perhaps to buy a house or help pay for college, you shouldn’t put it in the stock market.
The stock market isn’t for gamblers. In most cases, it’s for people who want to grow their savings through a diversified investment plan in which stocks are one part. That plan might also include fixed-income investments, real estate, and commodities. If you can’t afford to lose it, you shouldn’t risk it.
Will the ups and downs on Wall Street make me a nervous wreck?
Between cable television, the Internet and wireless networking, the average investor can follow the movements of the stock markets from the opening bell to the close. If you’re someone whose emotions will swing with every bounce in stock price, you might go crazy worrying about your investments.
There was a time when a 100-point swing of the Dow Jones Industrial Average was headline news. No longer. In today’s trading, it’s not unusual to see the Dow plummet in value, only to recover the following day.
When those swings happen, it’s important for investors to stay disciplined and think long-term. Can you tolerate that type of activity? If your honest answer is no, congratulations. You’ve recognized that realty about yourself before risking your money.
If that’s the case, consider more conservative investments such as U.S. Treasury bills or certificates of deposits (CDs). They offer a smaller return, but also lower risk. You’ll sleep more soundly at night.
Do I have the composure - and the energy - to get the facts when I hear rumors?
With online trading, investors can buy and sell with the click of a mouse button. That's convenient, but it also makes it too easy for emotional investors to lose money.
Socially responsible investors deliberately inject a level of emotion into their investing by using their ethical principles as a screen. But dumping stock at the first whiff of trouble can be a knee-jerk approach, especially if the news ultimately turns out to be inaccurate or flat-out wrong. The price takes a fall on the news, the rash investor sells at a lower price, then the shares ultimately recover when the real story is told. But the damage to their portfolio has been done.
Do your homework in advance. It's time-consuming and demanding, and can be particularly arduous for socially responsible investors who base their selections on more than financial statements. If that's the path you've chosen, do the upfront work until you're comfortable with your investment. That will give you the confidence to hold your ground when bad news pops up.
Finally, when negative news does hit and it proves to be true, don't run to the door and sell all your stock at once. It might make sense to back out of the company or mutual fund by gradually selling your shares. You'll still be true to yourself and kind to your savings.