Successful investing over the long haul is challenging because you’re always facing off with market risk as well as your own biases. And surely enough, often times investors pose a bigger threat to their own portfolios than anything else lurking in the market.
Behavioral tendencies can lead to cognitive traps that ultimately deter you from acting in your own best interest. These sorts of biases are as common among professional money managers as they are with everyday investors; after it all, it comes down to psychology, and we’re all human regardless of our account size or track record.
How Bias Affects Your Investing Decisions
Consider the following from Business Insider which rounds up the 20 most common biases that are bound to influence (and likely screw up) your decisions:
We’re going to highlight five of these biases and point out an investing example of each one by listing a common symptom and potential cure.
1. Stereotyping
Symptoms
When hearing people speak ill of emerging markets you assume every developing country is doomed and become hesitant to invest overseas.
Cure
Do your own research and uncover the major economic drivers of various emerging markets; you’ll likely uncover that what drives the economy of Poland or Mexico can’t be judged through the same prism as what drives China.
2. Recency
Symptoms
You find yourself panicking and considering selling your long-term holdings after the market drops 5%, in the context of, let’s assume, +100% gains over the past five years.
Cure
Write down your long-term investing goals and read them to yourself during periods of heightened market volatility when the future seems murky. Remind yourself that you’re not a trader.
3. Overconfidence
Symptoms
You feel really bullish on where the Brazil ETF (EWZ ) is headed so you decided to ramp up your bet and buy the 3x version (BRZU ) instead.
Cure
Most investors don’t really need a leveraged ETF in their portfolio unless they are keen on amplifying certain parts of their exposure.
4. Information Bias
Symptoms
You find yourself feeling more and more unsure in your decision to buy a particular ETF, even when it aligns with your long-term strategy, the more you research and read other analysts’ predictions about the future.
Cure
Formulate a checklist for buying an ETF and only place an order when the trade meets all your criteria; some example criteria could be, “Is this the best ETF in its category for my objective?” and “Is this a price I feel comfortable paying and holding onto?”
5. Blind-Spot Bias
Symptoms
You find yourself aware of everyone else’s mistakes in the market and convince yourself that your speculative timing of purchases will continue to be very rewarding (…forever).
Cure
Don’t burden yourself with trying to time the market in the first place. There’s a plethora of academic research that demonstrates the pitfalls of investors trying to “outsmart” the broad market. Alternatively, you can commit to a dollar-cost averaging strategy if you’re too stressed out with making a purchase at the right time.
The Bottom Line
Biases are an inescapable aspect of human nature. The unfortunate thing is that they often lead us to make irrational decisions, in retrospect, which could end up in material losses in the case of managing your portfolio. Investors would be wise to always be skeptical, question their own approach, and be willing to roll up their sleeves and do their own research rather than take someone else’s word for it.
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