Updated: Jun 20
As a species, humans are irrational creatures. The decisions we make are questionable at times.
Being fully aware of this, we can use this to our advantage when investing.
Having a finance degree or investing knowledge no longer guarantees success in the investing world (or corporate world for that matter).
Take care of the mind, and our investing returns will take care of itself.
1. Herd Mentality
Most people prefer to do what the herd does, no matter how irrational it seems.
This can be hard to overcome as it runs deep in our blood as humans.
It’s hard to invest when everyone is selling in a bear market. It’s hard to sell when everyone is buying in a bull market.
Since we have so many ways and places to invest our money, this makes us even more susceptible to defaulting to the status quo.
We need to understand what we are investing in and ensure we don’t fall prey to the fear of missing out (FOMO).
2. Disposition Effect
Hold onto losing stocks too long and selling winning stocks too early is a common mistake that many investors make.
Continually selling our winners to allocate to our losers may lead us to a portfolio full of losers.
This is akin to plucking out the flowers and watering our weeds.
The greatest asset of a long-term investor is time.
Don’t waste time watering your weeds, only to be left with a losing portfolio.
3. Hindsight Bias
Hindsight is 20–20.
In hindsight, everything seems so obvious. Because the past looks so obvious in hindsight, we risk becoming overconfident in predicting the future.
The market was in a bubble in 2021. I’d bet not many took advantage of this.
Timing a market top & bottom is a fool’s errand.
4. Recency Bias
Our minds tend to naturally gravitate towards recent events. And we use recent events to predict what will happen in the future.
Just because a stock has gone up as of late doesn’t mean that trend will continue.
Average investors buy stocks when they are up and sell when they are down.
The best investors adopt a long-term mindset and resist these short-term temptations.
5. Loss Aversion
Research has shown that people hate losses twice as much as they enjoy gains.
This aversion to losses may lead people to either invest too conservatively, or avoid investing altogether.
Loss aversion can lead investors to make emotional decisions such as:
Selling during a market crash
Holding too much cash
Under-allocation to stocks
Buying stocks based on recommendations from family and friends
Emotions are best left at the door when making investment decisions.
Many investors “anchor” to the price paid for a stock or have a “target price” at which they want to stock a sell.
Chances are you’ve heard someone say, “I’ll sell once the stock reaches $100 per share” after the stock had fallen to $50.
If someone buys a stock for $100, this $100 price becomes “anchored” in their minds.
Mr Market doesn’t care whether you own a stock, or how much you paid for it.
Just because you paid a certain price for a stock doesn’t mean that it has to return to that price.
Being confident about your investments is one thing. Being overconfident is a whole different story altogether.
Overconfidence can lead investors to take more risks than any rational investor would take.
Some of these include:
Which of these biases are you guilty of, and which you wish to eliminate?
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