Investors are, for the most part, rational. However, there are many instances where emotion and psychology influence our decisions and cause us to behave unpredictably or irrationally.
In this post, we will review a number of recent articles that shed some light on how to avoid making irrational mistakes with your investments.
In her Forbes interview with behavioural finance consultant Daniel Crosby, Kate Stalter delved deep into investor psychology to answer the question, "Do your investor biases doom you to low returns?"
Crosby revealed that while there are least 117 cognitive distortions that can impact investment decisions, he's been able to narrow those down to his top three:
1. Simple - To escape being overwhelmed, people need to apply some method of simplifying and prioritizing amongst all of their possible investment choices. But "if you simplify by always following the trend du jour," he says, "you're going to be in trouble." Instead, use your own personal benchmark when analyzing financial data.
2. Safe - To achieve a feeling of safety, investors may just do what everyone else is doing, which may lead to getting in and out at the wrong times. Real safety, Crosby says, comes from "boring best practices and sticking with it through thick and thin."
3. Sure - When a financial guru gives advice, it can seem like a sure thing. Yet Crosby cites research that shows there is actually "an inverse relationship between self-confidence of predictions and actual predictive accuracy." He says it's better to get your own customized advice rather than blindly following someone who is addressing everyone.
See: Do Your Investing Biases Doom You to Low Returns?
Shane Parrish of the Farnam Street blog says that when trying to make better investing decisions, it’s helpful to think about professional tennis games, where "professionals win points whereas amateurs lose them." To help amateur players transcend, Parrish recounts how Simon Rano created a strategy, "by which ordinary players can win by losing less and letting their opponents defeat themselves."
Parrish points out that an investor is really betting on someone else's game, and that amateur investors are much wiser to play not to lose. Instead of trying to be really smart, try to stay in the game by avoiding "stupid" decisions.
See: Avoiding Stupidity is Easier than Seeking Brilliance.
More than financial returns
Summing up her research for the Center for Talent Innovation at Inc.com, Andrea Turner Moffit shares some of what's behind the decisions of women investors.
Women want more than a financial return from their investments. They want a personal one as well – one that reflects their values and sense of social responsibility.
Some are turning to angel investing to fund entrepreneurs and start-up companies. Some are funding organizations dedicated to improving education, the environment, or global poverty. Others are committed to advancing gender equality.
The possibilities are enormous and so is the investment potential. In the U.S. alone, reports Moffit, women control over $11.2 trillion.
See: What You Need to Know About Women Investors.