“Investors often use rules of thumb or cognitive shortcuts that simplify decisions. In the world of behavioral economics, these rules or shortcuts are known as heuristics. But investors are sometimes blind to the mistakes they might be making when they use rules of thumb and shortcuts.
So, what are some heuristics that investors should use and which ones should they avoid?…
Bury your head in the sand. Likewise, pay no attention to the ups and downs in the markets. ‘Practice ostricity,’ says George Loewenstein, a professor of economics and psychology at Carnegie Mellon University and co-director of the Center for Behavioral Decision Research. ‘Don’t monitor your investments’ ups and downs.’
Others agree. ‘Don’t think much about fluctuations, even big ones,’ says Sunstein.
Don’t put all your eggs in one basket. Use the diversified portfolio heuristic. ‘Have a good mix of equities, bonds, cash; err on the conservative side if it brings you peace of mind; and use index funds,’ says Sunstein.
For his part, Loewenstein also recommends picking an investment strategy — a target-date mutual fund is a good option — and then adhering to it mindlessly. And remember, above all else, ‘it’s all about how much you put aside; not how you invest it,’ he says.
Retirees might also consider playing it safe given their time horizon. ‘In retirement, of course, your time horizon is shorter than it used to be, so it makes sense to invest in safe, less volatile alternatives: bonds instead of stocks, mutual funds instead of individual stocks, and so on,’ says Angner.”Read more at USA Today.