How to Avoid Temptations When Investing

June 10, 2022
Two powerful behavioral biases can affect your investment decisions—but here's what we recommend to prevent them from hindering your goals.

From cryptocurrency to meme stocks, the lure of seemingly easy money can be difficult to resist. "The reward center in the brain tells us we want something now, regardless of the future ramifications," says Adam Lynch, a senior quantitative analyst at Schwab Equity Ratings®. "But for most investors, the goal isn't to earn a quick buck—it's to build long-term wealth."

In particular, you should be mindful of two behavioral biases that can work against your best-laid plans:

  1. Fear of missing out: "FOMO is real," Adam says, "but if you feel like you have to get in now or you'll miss the boat, you're not thinking like a long-term investor." However urgent the opportunity may feel, it's essential you take the time to assess a potential investment's prospects vis-à-vis your financial plan. "When it comes to investing, impulse purchases rarely work out in the long run," Adam says.
  2. Social proof: If last year's meme-stock frenzy taught us anything, it's that social pressures are remarkably powerful. "You see your network making these outsize returns and think, Well, if they can do it, so can I," Adam says. However, it's important to remember the concept of mean reversion—which posits that an asset that has diverged from its long-standing price pattern will eventually revert to its historical range. Simply put, "That high-flying stock is likely to come down to earth," Adam says.

That said, if investing for you is as much about enjoyment and discovery as it is about reaching your goals, there's nothing wrong with setting some money aside to play around with. Just make sure to keep those funds separate from your long-term portfolio, lest such moves undercut your goals.

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