If you don’t have time to read through the whole article, you can check out our short version below:
Whether you are a rookie investor or a seasoned commander of your own investment destiny, be aware of these psychological traps:
- Sunken-cost fallacy: Falling in love too deeply with a company.
- Overconfidence: Thinking we always know better.
- Confirmation bias: Only hearing the things that back our views.
- Framing: Asking questions in a very limited manner.
- Home bias: Showing favouritism to what’s familiar.
- Greed and fear: Losing sight of the bigger picture.
- Herding: Following the crowd.
We all make mistakes. But the investment boo-boos we make don't need to be costly. Here's your quick guide to avoiding the Dark Side of the investment universe.
Markets work in cycles, and they don't move at the same speed. Unfortunately, when our investments show red, our palms sweat a bit more, and fear begins to set in. The "what ifs?" dominate, our thoughts are captive to the bottom line we see on screen….but here's a rapid-fire, five-minute read that you can apply before making any decision whether or not you consider yourself a rookie investor or a seasoned commander of your own investment destiny.
Let's say you've made some stellar returns from Company X three years ago. You bought more….and a little bit more. Since then, the stock has been on a roller-coaster ride, and its price has stagnated.
For most people, this is the hardest part: knowing when to let go. It's hard to let go simply because of all the time, effort or money you may have spent up to this point and this is commonly known as the "sunken cost fallacy."
But don't live in the past. Live in the present and rely on information in the present. Don't fall in love too deeply with a company, and be ready to fall out of love when it's time to let go. Does luck play a part? Let's not take that risk…especially when it comes to money.
Overconfidence. Think you have the "Midas" touch, where every stock or unit trust you buy turns to gold? But do you remember what happened to him? He died of starvation because he was focused on only one thing, according to Greek mythology.
Some of us have ended up winners because we have "trusted our gut." Truth is, we really do need gut checks. Overconfidence can stem from thinking we know better than the experts, or not following a logical step-by-step assessment and investment process. A single-market bias—when diversification is called for—could also be a flag for any investment portfolio.
As Warren Buffett once said, never invest in something you cannot explain or don't understand. And never be overconfident either.
Picture this: at last week's travel fair, you were handed a great deal on one of your bucket list destinations. You want to take it and you're really keen. But you seek your best friend's opinion, not because he is a travel expert but because you want some sort of affirmation that you're doing the right thing. And when he does give you the answer you're looking for, that's the confirmation bias you're after.
The confirmation bias scenario happens in many situations: the clothes we like; the phone we want to buy; the watch we want. It's the same with investments.
We may veer towards information or opinion to justify our pre-selected choices instead of going with properly researched solutions that don't gel with your current bias.
Have you ever framed a question to get the answer you want? Or find yourself asking questions that can only be answered by a "yes" or "no" with no option for detail or explanation.
If your answer is yes, then you need to think about reframing your questions to ensure that there's also a "why" at the end of it.
Home bias is a common investment trap that can be easily avoided. Investors may look to their home market or in a particular sector because it may be something we understand better and give it an "overweight" rating when it may not deserve one.
There is also a tendency to invest in our home market because of the advice we receive (see below!) or because we feel that we can monitor it more closely, especially since markets are open when we're awake.
Home bias can work against you. Use all available tools and build a diversified strategy able to weather any storm.
Greed and fear. These are the two biggest killers of investment returns, especially when you fall into a trap of buying high and selling low emotionally and irrationally. Keep your eyes on the bigger, longer-term picture instead of how the market is performing on the day itself. Stay on target!
Much like investing with an emotional lens, investors may also follow the crowd, or "herd". This is when an investor is heavily influenced by actions of your friends, acquaintances or family.
Always do your research, and even if something looks good as an investment opportunity, don't put all your eggs in the same basket. Ensure that you have some diversification, and that your asset allocation strategy is able to weather time horizons and different types of headwinds – forex, macroeconomics, politics, company earnings etc.
These myths, tips and tricks aren't meant to be taken at face value. This is your chance to put your newfound knowledge to good use.
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