06/09/2014 04:07 pm ET Updated Aug 09, 2014

Hitting Your Portfolio Eject Button?

You know what you want from your investments. You know or think you know what you should do with your investments. Yet, are you aware of how the typical investor actually behaves? Small or large, in this case, size of the investment doesn't seem to matter so much.

The Basics

Let's begin by reviewing one of the most basic tenets of successful investing. You can find this sort of wisdom touted by everyone from Warren Buffet to Charles Schwab. This tried and true wisdom tells us that the successful investing comes from sticking with it over the long term. This makes sense if you take a step back and reexamine the power of compounding.

Sort of like the interest on your personal debt keeps compounding. Savvy investors use the power of compounding in their favor. For example, something so simple as re-investing dividends over a period of years can significantly increase your results.

Successful investing also means focusing on buying high and selling low. Unfortunately, as you will see in just a moment, most investors do exactly the opposite, selling low and buying high.

Mirror Mirror On The Wall

It turns out that most people do exactly the reverse. Side tip: Do you want to really get a handle on how your investments get screwed up? Get up and walk over to the nearest mirror. Take a good hard look, there's the culprit. Not a blame game you understand, simply pointing out the obvious. It's the choices you make or don't make over the long term that matter. Now that this is out of the way, take a look at some broad investor types and the actions they take.

Stay Put

The stay-with-it investor does exactly that. These investors know and understand that optimum results come from a long term strategy. In addition, these stay put investors act the part. You won't find a say put investor day trading or any other such nonsense.

Not So Sure

The not so sure crowd has heard all about long term strategies. Yet, this investor can't seem to overcome the urge to pull out when the the market goes down. However, to their credit, these investors rarely completely exit the market.

The Panicker

The panicky investor pulls out at the first sign of trouble. The panicky investor is a text book example of what not to do in the investment arena. Time and time again, the panicky investor will end up selling at the low point and then getting back into the market when the prices are rising and getting higher by the day.

What's going on here?

Perhaps a bit of behavioral psychology will help make this clear. You see there are a couple of things going on here at the same time. On one hand, we as a species tend to feel of the pain of loss MORE than the pleasure of gains. Sort of perverse if you think about it too much. In other words, if someone nabs your wallet on the street, that hurts more than someone handing you a hundred dollar bill. Go figure.

Another bit of psychology comes into play with respect to timing and perception. For whatever reason, people tend to favor a reward right now more than a reward in the future. That is to say, the internal pleasure meter ranks pleasure available right now higher than pleasure next year.

Pain Points

Here's how this plays out. So imagine the market drops 15 percent or more in a single day. You panic and sell out and feel the relief of having gotten rid of the pain of watching your holdings lose even more value. But think about it: This is like the weirdo in the alley banging his head against the wall because it feels so good when he stops. Ugh!

One final piece of the psychology tie in is what is referred to as loss aversion. Loss aversion shows up on both sides. Consider: If stocks are increasing in prices, there is the pain of not participating in the rally. On the other side, when the prices are plummeting, there is the feeling the pain of loss.

Anyway, in case you weren't following along, this is exactly how the wrong investment strategy of buy high and sell lows shows up time and time again.

Now What?

Now that you understand what's going on between your ears you can take a step back and examine your past actions. Take the time to review some of your recent investment decisions. Did you or did you not have a sound reason for that decision? As illustrated above, hitting the panic button is rarely the best or even the next best strategy. Learn from the pros and consider a long term strategy. At the same time, take a moment and review a unique a strategy for investing in the stock market, even when you are scared!