Have you ever made an investment mistake? Looking back at what led to the mistake could help you identify potential triggers that might prevent you from repeating the error.
When you first think about why an investment decision was “bad”, the lower-than-expected investment returns may be what comes to mind. As you contemplate what led to your decision, you might link it to a lack of information or factors outside your control.
While these may have played a role, there are often psychological reasons behind your choices. Investment decisions are often influenced by emotions or biases, which could lead to investors acting irrationally.
Here are four psychological reasons why investors make mistakes.
1. Emotions could cloud your judgement
Investment decisions should be based on data, such as risk profiles or expected investment returns. Yet, this is rarely the case, as emotions are often involved. Even experienced investors can be affected by their emotions at times.
Consider periods of market downturns. Seeing the value of your assets fall could spark fear that might lead to hasty decisions, such as withdrawing your money because you’re worried that values will drop further.
The emotions that affect your investment decisions aren’t caused only by market movements or your finances. Perhaps work has been stressful, so you seek certainty and reduce your investment risk. Alternatively, a sense of security in your life could lead you to feel more comfortable taking investment risk.
2. Overconfidence may tempt you to try to time the market
Everyone would like to purchase assets at a low price and sell when the value peaks. The problem is that markets are often unpredictable, and the values of assets are prone to experience peaks and troughs that are impossible to consistently time.
Rather than achieving the highest returns possible, trying to time the market could mean you miss out on long-term growth opportunities. As a result, it often makes sense for investors to invest in a wide range of assets that align with their risk profile and hold them over the long term.
Feeling overly confident in your ability to time the market could lead you to take greater risk and disregarding your investment strategy.
3. Confirmation bias could lead you to overlook information
When you’re deciding how to invest your money, you might research different options. One of the challenges here is overcoming confirmation bias – the tendency to seek out or focus on details that support your existing beliefs.
For example, if you’ve subconsciously decided an investment decision is right for you, you may overlook information that suggests otherwise or that the valuation is likely to fall.
4. Following the crowd may feel safer
Being part of a crowd can feel safer. Making the same investments that your friends do or that you’ve read about in the newspaper can feel comforting.
Yet, large numbers of investors have been negatively affected by poor decisions. For example, in the late 1990s, the dotcom bubble developed as investors were eager to own a portion of internet companies on the expectation that their values would soar. During the crash that followed, many online businesses collapsed and investors lost money, some because they had followed the crowd.
What’s more, an investment decision can be right for one individual but wrong for another. Perhaps your colleague whose investment strategy you’re tempted to copy has different investment goals, financial circumstances, or risk profile than you. Blindly following the investment decisions of others could lead to decisions you later regret.
There are ways to limit the impact of emotions and bias
You can’t remove emotions and bias from your investment process entirely; they’re part of being human. However, there are steps you might take to reduce their impact.
Taking a break before making large financial decisions could allow strong emotions to settle. You might benefit from having clear goals you can refer back to. In addition, a financial planner could provide you with a different perspective and guidance. If you’d like to talk to us about your investments, please get in touch.
Please note:
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.