While there are plenty of instances where our unconscious thought processes serve us well (like when avoiding physical danger), they often don’t apply in today’s modern world. Quite simply, those reactions were developed to help us survive as cavemen (or gals), not to get an office promotion.
This is a truism in investing, where success is usually completely counterintuitive. With that in mind, here are some mental biases that could be throwing you off in investing:
Loss aversion
Studies show we’re about 2.5 more likely to notice a loss over a gain. That makes sense when it comes to noticing a dangerous lion over a tasty fruit, but not in the stock market. When there’s a drop in the stock market, this bias rears its head and tempts you to sell your investments at a low.
Ironically, because you’re hardwired to notice loss, you’ll end up creating a bigger loss over time when you attempt to avoid short-term dips in the stock market.
Recency bias
Our minds are also trained to notice recent trends and assume that they’re more likely to happen in the future. This can be a dangerous assumption in investing, both in good or bad times. In good times (when your investments are doing better than usual), this bias can tempt you to pile more of your wealth into them. In bad times, you’ll be led to think your investments will continue losing indefinitely, and sell out of them.
Either way, you’ll be fooled into believing you can predict trends that are actually anything but certain. While long-term data is a core part of smart investing, attempting to forecast short-term trends is more akin to gambling.
Overconfidence
There’s a fine line between having hubris and healthy confidence, especially investing. Having the confidence to withstand inconsequential movements in your portfolio is one thing, but believing you’re the next Warren Buffett is an entirely other manner. Unfortunately, studies suggest we gravitate to the latter. You can back this trend by sticking to your investment plan instead of falsely chasing more wins in the short-term.
If you found this advice helpful, be sure to visit my firm LexION Capital’s blog to learn more.
