How To Stop Making This Common But Costly Investment Mistake – The Madison Leader Gazette

Is your mind playing tricks on you when it comes to investing?

It’s no secret that everyone should invest for the future. Even if you are extremely risk-averse, investing your savings in stable investments like exchange-traded funds (ETFs) or bonds will likely generate significantly higher returns than putting your money aside in a bank account. But investing involves risks that do not arise only from natural market fluctuations. A recent study by Charles Schwab found that over the past year advisers have noticed an increase in behavioral biases when it comes to their clients’ investment strategies. There are therefore psychological foundations to your investment traps.

It’s not a huge surprise. With the development of investments like the rise of even stocks, more and more people are turning to their investments as a way to get rich quick. While these types of mindsets pay off for some, they can have financially devastating consequences for others. That’s why it’s a good idea to take a step back and take a critical look at how behavioral instincts can affect your approach to investing. A financial advisor may also be able to help, so consider using SmartAsset’s free advisor match tool to find qualified advisors working in your area.

Behavioral biases in numbers

Conceptually, it’s easy to take a look at behavioral economics concepts and think of them as rookie mistakes, or even mistakes you wouldn’t make yourself. However, the proof is in the numbers. The results of Charles Schwab’s recently published study on the impact of behavioral biases on client portfolio performance are striking.

Over the past few years, Charles Schwab has asked his advisors to measure the behavioral investment biases they see in their clients. Between 2019 and 2020, counselors reported an average fluctuation in behavioral biases of just 3%, with some biases increasing and others decreasing. However, in 2021, counselors reported an 18% increase in behavioral bias on average.

The story continues

Some biases stand out more than others. Recency bias, which causes people to favor recent events over historical trends, increased 58% in 2021, a 35% increase from the previous year. Confirmation bias, a tendency to recall information in a way that suits your preferences, and framing, which influences choice based on surrounding data, both increased by more than 25% year over year. former.

What are the behavioral biases in investing?

Behavioral biases are common in life and in investing. One of the most common is the hot hand fallacy, or recency bias. Let’s say you make three excellent but risky stock picks in a row. Many people, from this data, will infer that they are extremely talented investors and make riskier stock selection decisions, believing that they are forced to repeat their past successes.

However, past performance is not necessarily indicative of future success. While it’s certainly a good thing that you were able to make three good stock decisions, you shouldn’t assume that you could make three more. This type of mindset often causes people to make increasingly risky decisions to try and capitalize on that success, and this often doesn’t yield the same results. You could wipe out the gains you’ve made, or even go net negative.

Examples like these are common in the world of finance and investment. Another is what is called perspective theory. Someone who has lost $ 1,000 in a casino overnight is much more likely to double down and place bigger and bigger bets to make up for their losses, although they are likely to make those losses worse. .

In an investment context, a person who has lost money on a particular investment is more likely to stick with that investment or even buy more, in the hope of making up for their initial losses. While this sort of tactic can lead to future gains, it could just as easily cause you to invest more money in a losing investment.

Why has behavioral bias increased?

If there is one factor that connects the events of the past two years, it is the COVID-19 pandemic. The drastic market downturn and the market recovery that followed made the investment markets more sparkling than ever. While millions of people cannot afford basic necessities, many are making a lot of money in the stock and real estate markets, resulting in market conditions that defy traditional history.

Interest in retail investing has also exploded, particularly since the short-lived GameStop events of January 2021 and beyond. More people than ever are investing through online brokers and apps like Robinhood, leading to further market inefficiencies that many are capitalizing on.

In the vast majority of cases, being a successful investor requires taking a long-term approach. While it is true that anyone can profit from market inefficiency and see huge gains immediately, not everyone can profit from market inefficiency and see huge gains immediately. Nonetheless, it’s an attractive idea and has led to a sharp increase in behavioral biases as people try to take shortcuts to massive returns.

How can you protect yourself and your property?

Almost all of us are subject to the instincts that make behavioral biases thrive. When you buy a stock and it immediately climbs 15%, it’s easy to believe that you have an innate ability to replicate that choice over and over again. But even if you truly are one of the best investors, it’s important to recognize that past results are no guarantee of future success. You shouldn’t hesitate to adopt a rational investment strategy because of a few outliers.

During a market downturn, it’s common for investors to panic and sell their investments at a fraction of what they were bought for. However, if you are a long-term investor, being able to recognize market trends and weather the storm is a valuable skill that can keep your investment portfolio healthy over the long term. It is natural to have the behavioral instinct which is a recency bias, but being able to overcome this instinct and see it objectively is the rational decision.

Final result

Ultimately, the way to protect yourself against behavioral biases in investing is to be aware that they exist. Instinct is something we all have as human beings. However, putting these instincts into context can prevent you from making irrational decisions. As scary as a market downturn can be, don’t stray from rational investment approaches. Your financial advisor may be able to help you contextualize your investment decisions and keep you on a stable track.

Tips for investing

• Investing is not always the easiest task. From choosing investments to managing behavioral biases, there is a lot to think about. A financial advisor may be able to help you. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is best for you. If you’re ready to find an advisor, start now.

• If you’re investing on your own, it’s a good idea to be well prepared for what the market may hold in store for you. SmartAsset has you covered, with a number of different online resources you can use to make smarter financial decisions. For example, check out our investment calculator today.

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The article How to Stop Making This Common But Costly Investment Mistake first appeared on the SmartAsset blog.