... Understanding and avoiding behavioral pitfalls will ultimately have a greater impact on investing success than any other factor. Since emotions and subsequent behavioral pitfalls are frequently associated with miscalculating risk tolerance and asset allocation, the new investor should be aware of behavioral pitfalls before making asset allocation decisions.
“Financial decision-making,” says psychologist Daniel Kahneman in Zweig’s book, “is not necessarily about money. It’s also about intangible motives like avoiding regret or achieving pride.” ...
I've seen the overconfidence thing in action, both in myself ... and in others.
Back in the late nineties, I thought I was an investing genius, because my investments were rocketing up and I decided it had to be because of my wonderful genius.
It was because just about any stock fund was going up 15-20% a year, and tech stocks were going up 60%-80%. I ran into union members who had ALL their 401(k) money wrapped up in the Plan's tech index fund, and they were ecstatic. They had talked themselves into the insane idea that tech was magical, and would go up forever.
By 2002 and 2003, they had been persuaded that such was not the case, and that markets can indeed go down, and go down hard. I found this out during the same period, when I watched my S & P 500 melt away to the point where I finally bailed, and so locked in my losses.
Genius. Pure genius.
Below, find a list of emotional pitfalls that you should work overtime to avoid:
Being overconfident in your investing abilities can lead to big investing losses. ...
Loss aversion is the emotional tendency to strongly prefer avoiding losses over acquiring gains.
A human instinct that causes individuals to mimic the actions of a larger group rather than decide independently based on their own information.
Basing decisions or estimates on events or values already known (the “anchor”), even though these facts may have no bearing on the actual event or value.
A tendency to seek information that confirms one’s existing opinions and overlook or ignore information that refutes them.
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long coin flipping streak of the same value (such as heads) must end by changing to the other value (tails).
The tendency to draw conclusions about the future behavior of an investment from only the recent past.
A theory that says people anticipate regret if they make a wrong choice, and take this anticipation into consideration when making decisions. Fear of regret can play a large role in dissuading or motivating someone to do something.
The tendency for people to put their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors.
Paralysis by analysis
Investors have thousands of funds to choose from plus an abundance of market “noise” telling them what they should do. The more choices they have, the harder it is for them to choose one, making it more likely they won’t make a choice and will fail to invest. ...
You really need, as much as you can, to drain the emotion out of investing. Construct your investment plan and stick with it. Resist fear and greed. Twenty years from now, you will be much better off.