We Can Be Our Own Worst Enemy When It Comes To InvestingSubmitted by Castlebar Asset Management on August 28th, 2014
As humans, we all have tendencies or rules of thumb we use on a daily basis. The rules of thumb usually work so we don’t check to make sure if they are accurate. When it comes to investing we can bring similar behavioral tendencies that can sometime work and sometimes trip us up. Here are few behaviors that we come across in daily like that may impact our finances.
If you have every tried to buy a product online that you really wanted but before you purchase it you check out some of the reviews. When you checked the reviews you read four or five positive reviews and felt comfortable that this product was perfect and you then buy it. This is an example of confirmation bias. In investing, if you like a company, mutual fund or investment and only seek out advice or research that supports your opinion, this is exhibiting this behavior. The way to counter this is while shopping at Amazon.com or buying stock in Amazon.com is to seek information that is contrary to your current opinion. Look for a negative review or contrarian research to get a different perspective.
Everyone has one has a friend who always seems to root for the team that is doing great at the movement. Bandwagon fans are something we are all accustom to but never want to be accused of being. In investing, there are always new hot companies, sectors or investment strategies that attract the same bandwagon type behavior. Making investment decisions because of popularity is making an investment on fear and greed. Neither are good for accomplishing your goals long-term. Recognizing if you are jumping on the bandwagon is easy. The key is to minimize your risk if you do decide to jump on!
If you are the type of person who values something you own more than something that you do not. This is called an endowment effect. If you own a stock that you have lost some money on while other companies in the same industry are more attractive, yet you will not sell your losing stock to buy a better company. This is an example of the endowment effect or bias. You have to look at things objectively because your stock is no longer the best in the industry and it is better to move on.
Bill Simmons often describes a basketball player who is only average but thinks he is a superstar as the “irrational confidence guy”. When this player gets in the game, they are going to shoot no matter what. If they make a few baskets than look out because no one is seeing the ball again. Novice investors can experience the same overconfidence after having short term success in the market. They can feel like they have an edge after making a few correct calls but do not have a long term track record. An experienced investor can recognize if they start to brag about performance and when to stop such behavior.
Over the next several weeks I’ll highlight a few more behavioral biases that could influence our daily and financial lives.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.