I find behavioural finance fascinating, being interested in money and psychology. Essentially, we are our own worst enemy when it comes to investing. We are more motivated to avoid loss than to acquire gain. Pro athletes often say they’ll trying not to lose more than they’re trying to win. We are also of course driven to varying degrees by greed and fear.
Many investors lose out by panicking when the market drops, and selling at the worst time. This is our fear of loss. Doubtlessly if you see your portfolio drop by 30% overnight (thankfully I haven’t had the experience yet) there’s a huge temptation to cut your losses and sell. By doing that we are ‘crystallising’ our losses; ie they are now real rather than just paper losses.
It is reported that Warren Buffett’s paper wealth dropped by 23 billion dollars in the 2008 crash. Now he still won’t have been been left in poverty, but he only actually suffered the loss if he’d have sold at the bottom of the market. Being a (very) long term investor, he knows to sit on his hands and ride it out. Indeed he refers to it as a fire sale – the perfect time to buy into the market. That’s where real gains are made.
People who have panicked and sold at the bottom of the market often also miss the gains as it rises, by waiting too long to get back into the market. They therefore sell low, buy high.
You see examples of this everywhere. We have a tendency to see evidence which backs up our beliefs, what ever they are.
Thinking that we predicted the last crash, so we will again. We didn’t, and we won’t!
A tendency to give too much weight to passed experience, or the first relevant information we come across. Similar to confirmation bias, in that we can be anchored to a theory/concept etc, and go looking for information to support it.
The best friend of marketers, this preys on our tendency to concentrate on a story, not the underlying facts (that Bitcoin trader’s stood next to a Lamborghini, so this stuff must work!)
Self Attribution bias
Wrongly giving ourselves credit for something. As they say, a rising tide lifts all boats. Good investors make money regardless of what the market is doing.
This is our tendency to believe that most people think like we do.