To be a successful investor it is essential to understand and overcome the biases that often lead to wrong investment decisions. A common misconception, especially among many new investors, is the belief that investing in the stock market can make them rich overnight.
The scenario seems real in that some investors end up making big gains at one point, but in this case, more often than not, the investment was made years ago.
Success is due to patience, emotional intelligence or vast experience rather than luck or a great trading opportunity that “struck” overnight. Financial literacy and staying up-to-date with the most important news and events are ingredients that also make the difference between investment success and failure.
The stock markets are constantly changing and it is not good to expect big and quick gains. This fact does not help you concretely, but, on the contrary, adds even more pressure on you.
That is why, before you actually enter the market, review the relevant information and be aware of the associated benefits and risks.
Perhaps along the way you will be pressed for time and this will make you want to “cut corners”, simplify complex decisions and thus become overconfident in your decision-making process. But keeping your expectations realistic not only gives you a balanced point of view, it also helps you be rational.
Moreover, because the decisions you make trigger certain processes, biases can actually prevent you from having an optimal approach (optimal does not mean perfect!).
At times when you seek to be perfect in this area, you begin to give too much importance to some things, leaving others on the outside.
With limited resources as an individual, it is better to seek an optimal and not a perfect allocation of them, because the inevitable errors will drain your energy and make you lose your focus.
You have to remember that in investing, you don’t aim for the impossible, you just have to eliminate the errors to become constantly better.
That is why, if you avoid major mistakes and have some understanding of the markets and the economy, the odds of becoming a successful investor are completely in your favor. But don’t think that this is the secret to becoming rich overnight.
Those who are extremely confident and also have the misfortune of having…luck in the beginning, believe themselves far above the level of those who have some experience and have also recorded losses among their gains.
But these lucky beginners will be the most shocked by the markets, and the return to the ground will be more painful for them.
By constantly learning about “investment psychology” you will know how to manage other emotional errors that can occur in any investor.
The most common prejudices and preconceptions that can lead to wrong investment decisions:
- Confirmation – some investors are overconfident in their decisions, focusing on data that seems to confirm, rather than disprove, this.
- Attraction to “sensational” information – as investors are bombarded with a plethora of information every day from financial commentators, newspapers and stockbrokers, it is difficult for them to filter it to focus on the relevant information.
- Aversion to potential losses – some investors refuse to sell losing investments in the hope that they will get their money back. But, in addition to money, they can also lose their self-confidence.
- Incentives – the power that earnings and incentives can have on human behavior often leads to exaggerated frenzy.
- The tendency to oversimplify – in seeking to understand complex matters, investors tend to want simpler explanations, but some matters are inherently difficult to explain and do not lend themselves to simple approaches.
- Hindsight – this state of mind prompts investors to eliminate objectivity in evaluating past investment decisions and inhibits their ability to learn from mistakes.
- Confidence Transfer – Speculative bubbles are usually the result of groupthink and “herd” mentality. This concept describes a certain kind of inner comfort that an investor can feel when they think that “others are doing the same”, even if their decision is not necessarily a good one.
- Neglecting probabilities – investors tend to ignore, overestimate, or underestimate the likelihood of outcomes other than those they have calculated. Most are inclined to oversimplify the process and allocate a single point estimate when making certain decisions.
- Anchoring in the past – represents the tendency of investors to rely too much on a reference or information heard in the past when making a decision.
To remember :
- Understanding these biases can lead to better decision-making, which is fundamental to reducing risk and improving investment returns over time.
- Shortcuts especially do not work in the financial capital markets. Make sure you follow a disciplined, rational and balanced approach to investing, always keeping in mind the long-term perspective, company fundamentals and market analysis of the sector concerned.
- Investors who want to take shortcuts often end up losing their invested capital and blaming the markets for their own preconceived decision.
- The reason our mind tends to simplify or make decisions based on trusting certain situational patterns without applying its own filters is because it wants to reduce energy. Thus, if you are just starting out and want to become a profitable investor, you need to make sure you have the mental energy and patience to avoid these prejudice traps.
- Financial literacy is what makes the difference between investment success and failure. Invest in yourself first, in your education, to make sure your money starts working for you and not the other way around!