5 investing psychology traps you must avoid

January 30th 2018 | Categories: Investing |

hands using scissors to cut a tangle of silk ribbon

Money can play terrible tricks on the mind, which is why even the shrewdest investors may fall victim to illogical thoughts when cash is involved.

The human brain is capable of astounding accomplishments. We’ve developed complex languages, created technology that allows us to walk on the moon and built sophisticated structures that have survived thousands of years.

But when it comes to money, even the most intelligent people can make mistakes that prove costly for their personal finances. This is why seeking impartial investment help and advice from financial planning experts is often recommended when trying to grow your wealth.

Speak to one of our advisers to avoid these Investing psychology traps.

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Here are some of the most common psychological mind-tricks that profitable investors must try to overcome if they want the best chance of achieving higher returns.

Veteran investors are more likely to buy stocks when the sun is out, while cloudy conditions cause people to avoid risking their money.

1. Herding

Ignoring our survival instincts is always difficult, which is why herding is such a common phenomenon in the investment world. Herding is when numerous people follow a trend, such as buying a particular stock or moving into a new investment class.

This may work in the animal kingdom, where there is safety in numbers, but blindly following the pack can prove disastrous when investing. In fact, doing the opposite to everyone else can often be lucrative; if other investors are dumping a stock, for example, now may be the time to buy while it’s at a low price.

2. Confirmation bias

We’ve all been guilty of confirmation bias at one time or another, especially when discussing topics that are close to our hearts. Essentially, confirmation bias is when an individual places higher value on information the reinforces their pre-existing beliefs while downplaying opposing opinions.

Do you believe the Australian property bubble is about to burst? Or that tech stocks are going to outperform the market? Chances are you’re more likely to believe the research that backs up your opinion rather than objectively judge the available analysis on merit.

crowd of anonymous people at a trade fair
Following the crowd can be a bad move when investing.

3. Loss Aversion

Humans hate to lose. We hate it so much that studies have suggested losses have twice the impact, psychologically speaking, as gains. This can result in illogical decision-making, whereby people will go to extraordinary lengths to maintain even the slimmest opportunity of winning.

The repercussions for investors are obvious. Holding on to a stock, asset or other investment for too long, despite its dwindling value, can severely damage a portfolio. Shrewd investors know when to cut their losses and funnel their money into areas that have a better chance of delivering returns.

4. Anchoring

People are prone to fixating on particular reference points and basing all future decisions on that original event or outcome, which is a process called ‘anchoring’.

For example, if you invested money in a stock that performed exceedingly well in the past, you will continue to have a soft spot for that company in the future, even when it begins losing you money. Similarly, investors who were hit hard in the financial crisis may still be avoiding certain asset classes because they are anchored to previous negative outcomes.

5. Weather watching

Seasonal shifts in the weather have long been known to affect our mood. Sunshine and blue skies bring out the best in most people, whereas drizzly, overcast days are often linked with doom and gloom.

Well, Case Western Reserve University professors have found that weather can also have an impact on our investment decisions. They discovered that even veteran investors were more likely to buy stocks when the sun was out, while cloudy conditions caused people to avoid risking their money.

These five psychological traps are just a handful of the challenges that investors face when generating wealth for the future. To help you overcome any investment planning failures, why not discuss your needs with an expert? Get in touch with us today.

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What you need to know

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