With the stock market volatility increasing — sometimes hundreds of points each day — and interest rates approaching the magic number of 3 percent, many investors are confused and somewhat befuddled.
Who can blame them?
But, let’s not be our own worst enemy. As investors are swamped by daily events such as we have been experiencing recently, I would like to explore how our brains affect our investing decisions.
The science behind an investor’s brain and one’s thinking is fascinating to say the least.
Here are a few of the more common “brain games” investors are subject to.
Overconfidence
We tend to be overly optimistic about our knowledge. Most of us consider ourselves to be smarter than the average person.
It is harmless most of the time but can lead to taking greater investment risk than we can handle. We need to push our pride aside to counter our biases.
Don’t fall in love with an investment. Seek counter points and listen.
Information overload
Who isn’t overwhelmed with information these days? TV, the internet and 24-hour news outlets are vying for our attention.
Information fatigue can turn a rational investor into someone who can’t make a decision. Even worse, they make a wrong decision.
Turning points in the stock market can lead to investors doing the wrong thing at the wrong time. We can counter this by realizing that at some point more “breaking news” information only confuses things.
Remember to take the long term approach. And don’t hesitate to turn off some of those relentless “breaking news” reports.
Loss aversion
Research has shown that we regret loss twice as much as we like gains. What happens here is we tend to keep our losers and sell our winners. To quote Peter Lynch, this is like “watering the weeds and cutting out the flowers.”
Remember that all investors experience losses. Accept that losses and gains are a part of long-term investing. Keep a diversified portfolio and review your gains and losses each year.
Clustering
This is also known as the gambler’s fallacy. This is the tendency to see patterns where none exist and is a strong human characteristic.
It has served us well in the past, but not so much in today’s modern society. Today it can be very damaging by creating faulty data that we act upon.
This is often manifested by the chasing of last year’s hot mutual fund manager. While you may succeed a few times with this approach, sooner or later you will not.
This is the often-quoted expression of “past performance is not indicative of future results." A better way is to admit that we are all vulnerable to this fallacy.
It’s in our DNA. Seek out independent analysis of an investment and quiet the “noise” surrounding it. Then invest
Confirmation and hindsight bias
Both of these reflect back a distorted view of reality. One is we seek only information that confirms beliefs we already hold. This is confirmation bias. It can be countered by seeking other views of the investment potential.
Hindsight bias is the “I knew better” when talking about a misstep. Looking backward it seems easy to see what we should have done in that situation. But, in reality, one doesn’t know what the future will bring.
Realize that investing is about the future not the past. The future is not so easy to predict. The past seems easy simply because it has already happened.
We can’t change in major ways our basic human nature. But, we can understand our tendencies or biases and learn to adjust to them. Remember that money managers understand the value of mastering emotions. It helps to give them a winning edge. You may have an investment coach already. That would be your investment adviser. Most of us are well trained in these and other “brain games” that you need to master to be a successful investor.
We are a simple phone call away. Give us a call. We can help.
Michael T. Doll, an investment adviser with the Longboat Key Financial Group, can be reached at 941-896-2437, or at michaeltdoll@longboatkeyfinancial.com.