The Psychology of Investing

The psychology of investing

JLI was reading a book recently entitled The Zeitgeist Investor written by Tim Richards, which is all about what happens when our brains and the stock market collide.

Without wishing to paraphrase the book, I picked out 7 psychological biases and traits that we humans are often subject to, which can end up making smart investing more difficult than I believe it should be:

1. Listening too closely to pundits

It is often forgotten that the ‘news hour’ usually contains 15 minutes of actual news and 45 minutes of speculation – to make this more believable ‘pundits’ (so called specialists or forecasters) are used who give their opinion about what the future holds. As share prices change constantly based on latest company, political and financial information, science has proven that the pundits have no greater chance of getting their forecasts right than you or I.

HHW: Don’t base your investment decisions based on so called ‘expert’ predictions. Let’s be honest, if they could predict the market they’d live on a boat in Monaco; they wouldn’t be sharing that information with us.

2. Hindsight

Market forecasters spend a lot of time telling us why the market behaved the way it did. They’re great at telling us we need an umbrella after it starts raining as well, but it doesn’t improve our returns. We’re all useless at remembering what we used to believe.

HHW: The past is history and tomorrow is a mystery.

3. Loss aversion

At Holland Hahn & Wills we know that our clients feel greater pain over losses than pleasure over gains. However, shares don’t have memories so you should decide on whether to buy or sell independently of the current share price.

HHW: Ignore buying prices when deciding whether to sell (unless you are a trader).

4. Regret

We should invest based on our judgement, fully taking our requirements and attitudes towards risk (and loss) into account. Sometimes the market goes down and sometimes it goes up and it is difficult (some would say neigh on impossible) to predict when the best time is to invest. If you are unlucky and buy just before a downturn, you may feel regret at your decision and potentially sell, wanting to ‘cut your losses’. At Holland Hahn & Wills we think about money in a different way. Historically, over the long term, markets have been profitable, whenever you buy – it’s the time in the market that counts the most. A strong investment discipline will prove successful over time.

I once heard an American fund manager speaking to an investor. The investor said how they had lost money in the stock market. The fund manager incredulous, said, “How is that possible, in 1975 the S&P 500 index was at 72 points and now it’s over 2000.” His point being that if you are invested for the long term you don’t lose money. That only happens if you buy and sell with a short time horizon in mind.

HHW: Don’t make short-term snap judgements over long-term investment decisions.

815ddf0e-a3ea-4e09-ad61-2904bc662e915. Anchoring on statistics

Research has shown we have a tendency to ‘anchor’ on specific numbers. For example, people love to hear about the highest value of the FTSE 100 index and then speculate on whether we will ever beat this figure (and consequently whether it is a good time to buy or sell).

HHW: Don’t get fixated on statistics.

6. Bias towards recent events

We pay more attention to short-term events than the longer-term. So the effect of a short-term downturn in the markets may be exaggerated, or we may simply assume that current market conditions will persist forever.

HHW: Investment is a long-term position, not short-term.

7. Confirmation bias

We love to hear other people confirming what we think. We therefore tend to ignore alternative opinions and seek out similar views amongst others. Investing isn’t a dark art and I believe it is possible for everyone to have a successful investment experience.

HHW: Make your own investment decisions based on logic, reasons and empirical evidence; don’t rely on what others think.

Conclusion

It is easy for all of us to fall victim to our very human psychological emotions and biases, this often leads to poor investment decisions and consequently poor investment returns. At Holland Hahn & Wills we believe that it doesn’t have to be this way. We invest our client’s money based on strong and very sound principles, based around our trademarked service: The Secure Lifestyle Approach®.

Further reading

  • Winning The Loser’s Game by Charles D. Ellis
  • A Random Walk Down Wall Street by Burton G. Malkiel
  • Smarter Investing by Tim Hale

If you’d like more information on our services please feel free to contact me on 020 8943 9229, or via email at jason.lurie@hhw-uk.com.

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