We’re all susceptible to confirmation bias – paying more attention to our own preferred data and largely ignoring contradictory evidence. For investors, this psychological blind-spot can be very costly.
In every-day life, we like to think that our decisions are logical, rational and objective but often they are anything but.
Balanced analysis frequently goes AWOL as our pre-conceived beliefs take over. Let’s take a General Election as an illustration of this point.
Voters often seek positive news that shows their favoured candidates in a glowing light while paying scant attention to information that casts the opposing candidate in a good light.
If their existing belief is that their party is always strongest on say, maintaining law and order, they may place greater emphasis on campaign speeches reinforcing this claim than independent figures showing cuts in police or army numbers.
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Emotions aren’t always your friend when it comes to investing. In fact, they can lead to trouble in some very specific ways…
Here’s today’s understatement of the year: emotion plays a major role in investing.
Whether it’s the gold rush leading to 2008’s crash, momentum trends that cause a stock to orbit its true value or the irrational exuberance of the 1990s, the stock market is filled with people who act like, well… human beings. Perhaps unsurprisingly, this has its strongest expression when it comes to individual investors.
That’s not always bad. Emotions come into any big decision, and it’s important to feel good about your portfolio. Emotions dictate risk tolerance, after all. The same goes for picking companies with a strong sense of mission. Those are the decisions that help you sleep at night.
The problems start when emotions become biases. That’s when you, as an investor, can make bad choices that don’t leave you personally or financially any better off. What do those biases look like? Here are the top ten to keep an eye out for the next time you open up the portfolio…
Bias: Focusing on an actual or perceived expertise on a narrow slice of the market
Overconfidence isn’t necessarily what it sounds like. Yes, sometimes this bias is caused by an investor who knows less than he thinks. That guy who caught 15 minutes of “Mad Money” and then gives lectures at a dinner party is a classic example.
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