What is the main reason that most people fail to invest successfully? Is it a lack of information, too much information, a lack of time to devote to investing, a lack of investing knowledge, lack of tools, or just plain old bad luck?
In most cases, the main cause of poor investment return is the person looking back at you in the mirror. It is our behavioral tendencies that we as humans use when making investment decisions.
The field of behavioral finance attempts to identify what it is that we do in our heads that negatively impacts our investing outcome.
The Academy of Behavioral Finance & Economics website lists over 100 on these tendencies or traits.
Here are just some of the mind games we use or are impacted by when it comes to making investment decisions. Which ones have impacted you?
- Fear of change, which results in the status quo
- Fear of making an incorrect decision
- Greed or the strong desire to get rich
- Overconfidence in thinking we know more than we do or more than what other people know
- Loss aversion, strongly prefer avoiding losses to acquiring gains
- Herding is the tendency for individuals to mimic the actions of others, which is based on the social pressure of conformity and is supported by the belief that it’s unlikely that such a large group could be wrong
- Hyperbolic discounting is when people want a “payoff “sooner than waiting for bigger “payoff” later
- Anchoring on irrelevant data rather than concentrating on more relevant data
- Overestimating or underestimating possible outcomes based on recent memorable data or experiences
- Reluctant to admitting mistakes or judgment errors
- Believing that investment success is due to wisdom when it was most likely due to a rising market
- Confusing familiarity with knowledge
- Elective thinking is the process by which one focuses on favorable evidence in order to justify a belief, ignoring unfavorable evidence
- What is an investor to do to avoid these types of pitfalls?
- The answer is to have a structure or a methodology in place that can prevent a lot of the mind games people otherwise may allow to impact their investing.
- Know your investing goals
- Have a written plan that dictates the method of how the investments will be managed. This is often referred to as an Investment Policy Statement (IPS)
- Design the portfolio using a prudent methodology
- Monitor the portfolio
- Rebalance the portfolio based on the IPS guidelines
- Change your investment allocation over time
The reality is that most people do not have the time, the motivation, the tools or the knowledge to properly invest properly.
The question is, “Are you are hindering your investing success?” If you are or if you do not know, you may well be better off having a professional help you.
To find a “fiduciary” investment advisor (always keeps your interests first, unlike a sales person) go to the websites of the National Association of Personal Financial Advisors or The Garrett Planning Network.