This emotional approach to investing often results in buying high and selling low, the opposite of what most of us want to do. For example, investors poured money into mutual funds at the height of the market before the technology bubble burst in 2000. Some of this activity is fueled by "portfolio envy," where everyone around you seems to be making money, so you climb in as well.
But whether the Standard & Poor's 500 is up a certain amount or your neighbor is making a killing shouldn't matter to you. Your strategy should be based on your individual goals, time horizon, and risk tolerance, not those of your neighbor. If you follow the herd into an investment you run a good shot at buying near the top. Similarly, the greatest volume of selling is generally near market bottoms, when the news headlines are the most dire and a turnaround seems most improbable.
Last year people poured money back into stocks as the market climbed. But then debt problems in Greece created worries of a double-dip recession. People sold their stocks and ran for cover, which added to the market's volatility last spring.
What to do instead
Put your investments on autopilot. Set up an appropriate asset allocation and make regular investments at set intervals, regardless of what the market is doing or pundits are prognosticating.
If you're still some years away from leaving the workplace, consider target-date funds, which shift their mix of investments automatically based on your anticipated date of retirement. They were criticized for their inability to protect investors from losses in 2008, but the funds performed well for people who stuck with them over the last two years.
In fact, target-date funds helped investors beat the S&P 500 by a full 6 percentage points in 2009, according to a study by the investment research firm Dalbar. This is because the funds "positively influence investor behavior," the study says. "Convinced that professionals are at work making prudent decisions instead of blindly pursuing a failed strategy, investors are less inclined to withdraw their money after a market downturn."