Knowing Human Tendencies Can Help Your Investing

March 20, 2017

The financial markets are tricky enough to navigate, but at times, investors of all stripes can complicate matters for themselves and are really their own worst enemies.  Many investing mistakes can be traced back to what finance psychologists term “behavioral biases”; simple assumptions or habits that are rooted in human nature.  Everyone is subject to these tendencies, even the professionals.  One key to overcoming these problematic habits when it comes to your investing is to understand them and considering alternative reactions when you catch yourself following these impulses.   Here are some common mistakes people make in this manner:

Confirmation Bias: This is the tendency to support a preconceived opinion or theory with data or opinions of others that agree with your opinion and exclude others without fully weighing the merits of opposing viewpoints.  

Anchoring:  A classic mistake of using a desired starting point to defend an investment strategy or point of view.  A good example is the reluctance to sell a losing investment until you (somehow) break even or recover what you’ve lost so far.  Same with losses at the gambling table.

Hindsight Bias: A favorite of mine when reading claims by “investment gurus” that past events were clearly foreseeable by them, so you should trust their future forecasts.  Basically an assumption that the past was easier to see than it actually was at the time.

Sunk Cost Fallacy: Reluctance to exit a losing strategy based upon the losses already incurred.  This is similar to anchoring, but weighs heavily on what has already been lost or spent.  People fall into this all the time when considering replacing an older vehicle that is constantly in the repair shop.

Patterning: Seeing patterns and repeatable circumstances where the truth is actually more random chance.  This is a biggie with so-called “technical analysis” in the investment world, where investments are made based upon charts and patterns in market activity.  There are many believers in this, especially on Wall Street and in the day-trading community.  Every religion has its followers and justifications.

Self-Attribution: This is where investors take credit for the wins and ascribe blame to others or other circumstances for the losses.  A good investor (or investment advisor) will downplay their skill in the wins (a lot could easily just be plain old good luck) and assume some of the fault for the losses.

Illusion of Control: More and more, especially today, investors need to realize that much of the activity in their investment accounts is far beyond their control.  There are literally billions of dollars that transact in the financial markets today and almost no one has any control over the markets or how the investments within their portfolio will change based upon market events or market behavior to those events.  To believe one can outsmart or outguess the market is largely illusionary.

Recognizing our natural fallibility to these human traits can be the difference between long-term success with your investment goals or making mistakes that can derail your financial plan.  Being self-aware is helpful in most aspects of life and especially so with your participation in the financial markets.