When you invest, your mind may be playing tricks on you, says Sheryl Sutherland.
Traditional economic theory says we’re always rational when we react to financial information or want to get the best deal. But, no.
Unfortunately, many of us invest on a hunch, through pride or envy, through peer pressure, or simply succumb to the financial fad of the time.
Others of us show financial snobbery by claiming to be a ‘contrarian’ by acting opposite to the trends, or to have insider knowledge.
Do you see yourself in any of these investing behaviours?
Luke Skywalker in the Return of the Jedi says, “Your overconfidence is your weakness”. This can be the case for many investors who think they know more than they do, control the results of their investments, and in this way, underestimate the risks.
Pride and regret
We avoid actions that we might regret later. If we sell a loser share, we consolidate our ‘losses’, the loss becomes real and we regret our purchase, so we hold on to losing investments in the hope they might recover. Pride makes us hold the winners, so we can congratulate ourselves on making a profit.
Stuck in the past
The effect of financial experiences we’ve had in the past is enormous. If we’ve had good returns in the past, we’re more likely to continue investing. If we’ve lost in the past, we become extremely risk-averse. And we tend to ‘reframe’ our views by magnifying past profits or past losses.
We handle money differently depending on its source. Consider winning NZ$50,000 from a casino. What do you do with the money? Probably spend it, because it’s a windfall. In fact, it’s well documented that more than 80 per cent of winners of large sums of money have lost it all five years later.
Investing is complicated. Our brains recognise this and take shortcuts to reduce the complexity of analysing information. This can lead to errors of judgement because we look for the familiar, easy option. For example, in New Zealand, it’s property. Everyone else is a landlord, so it’s got to be great…
Friends and Facebook
This source of influence is pervasive and persuasive. Friends, social media, and self-help books are a powerful force in our financial lives.
But don’t panic!
Don’t despair if you see yourself in any of these profiles. Read JUNO’s upcoming series on behavioural finance.
It may seem like the deck is stacked against you, but you can get successful outcomes by trying some simple strategies to overcome your habits and biases.
First published 8 June 2018
This article is part of the Rational Investor series by Sheryl Sutherland. Sutherland, of the Financial Strategies Group, is an investment adviser who has worked in the industry for the past 30 years. She’s also the author of multiple best-selling books.
A full disclosure is available by contacting firstname.lastname@example.org
JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions. This story reflects the views of the contributor only. Content comes from sources that JUNO considers accurate, but we do not guarantee that the content is accurate.