From a fairly young age, most of us are advised that we need to learn how to invest. We’re taught that this is just about the only responsible way to handle regular income and personal financial planning, even if many of us are never really instructed beyond this vague idea. Thus, for many at least, investing becomes unquestionably wise and fraught with difficulty at the same time.
The truth of the matter though is that studying up on specific investment strategies only alleviates that difficulty to a certain extent. We can learn the ins and outs of “proper” investing decision-making and still fall prey to two unfortunate elements of this whole initiative: chance, about which we can do little but plan accordingly; and psychology, which is something it takes a great deal of knowledge and discipline to circumvent.
Simply put, we have known and documented psychological tendencies that we often fall into with regard to investing. That doesn’t mean every single person experiences the same issues, but it does mean anyone doing any sort of personal investment should at least be aware of the potential risks in this area. So with that in mind, we wanted to address five psychological issues to be aware of when you invest.
1. Loss Aversion
Some of the most basic psychology of investing, and to some extent human behavior in general, is that we tend to feel losses more profoundly than wins, or gains. For this reason, our aversion to losing money on an investment can elicit a more extreme reaction than our satisfaction at gaining money. As a result, people will often hold onto a failed investment too long, or even pump more money into it in the hopes of turning things around and erasing psychologically painful losses.
2. Trust In Experts
It’s human nature to seek out and trust experts; one could argue that the very word “expert” exists in part to identify these sources so that we might heed their advice. In investing, expert takes can sometimes be more visible than others. In the somewhat investing-adjacent betting business, the very platforms that help people to find odds and place bets are imbued with expert tips such that you almost can’t make a play without considering advice. This hasn’t typically been the case win stock investment, though some of the new apps that are replacing traditional brokers for people follow a similar pattern, interlacing expert advice with trade mechanisms. There’s certainly nothing wrong with taking this into account, and most experts have earned the label. However, investors would still be wise to beware human tendency to trust experts almost blindly, and to no end.
3. Herd Mentality
Herd mentality is a constant, ever-present phenomenon in investing of all kinds. Perhaps the most visible example at least in recent years came in cryptocurrency, when bitcoin experienced its otherworldly spike throughout the second half of 2017. All of a sudden, as the long-promising cryptocurrency started to rise in value, amateur investors who had never given serious thought to it hopped on the bandwagon, buying in at higher and higher prices to join the “herd” and get a piece of the gains. This doesn’t always have negative results, but it’s worth remembering that being first to the party is valuable in investment, and following the crowd therefore inherently leaves you with less proportional potential for gains. Additionally, herd mentality can cause you to base your financial decisions on crowd trends rather than objective reasoning or analysis, which is never a good thing.
Anchoring is actually a very interesting psychological phenomenon that goes beyond investing and essentially involves relying on one trait or piece of information, typically based on early experience, and ignore additional findings. The simplest analogy may be through sports. If the first time a fan sees a given basketball player in action, that player hits several three-point shots, the fan might be likely to consider the player to be a good shooter for years afterward, even if the broader statistics would say otherwise. Anchoring can exist in all different facets of life, but you can certainly see how hit can be harmful in investing. Relying too heavily on an initial experience buying shares in a company, or on something positive or negative associated with that company in general, can very easily cloud reasoning in the future.
Finally, there’s the simple human flaw of overconfidence. It’s very easy for investors to fall into, whether they’re just starting out and believe they’re clever enough to work the market, or they’re experienced and start to believe a hot streak is sustainable, etc. Confidence is fine, and to some extent can even be an asset in an investor. Taking it to an irrational level though, as so many of us are naturally inclined to do, can be another major psychological flaw.