Why Investors Do The Crazy Things They Do – Conclusion

imagesWhether it’s anchoring, gambler’s fallacy, overreaction or overconfidence, we are all guilty of these biases and irrational behaviors. I admit, I’ve done quite a few of these, so even financial professionals have emotions!

At the start, my hope was that after reading the series, you would be able to identify some of the behaviors and take corrective action.

Now that the articles are written, I can use them to show clients when these behaviors are starting to come out. It will be fun and more profitable to show how the mind negatively influences our behavior.

Here’s a summary of the articles:

  • Behavioral finance is a relatively new field that tries to combine behavioral psychology theory and economics and finance to explain why people make irrational financial decisions.
  • The concept of anchoring is the tendency to attach or anchor our thoughts to a reference point. In many cases there is no logical reliance to that reference point.
  • Mental accounting is the tendency for you to separate your money into different accounts based on subjective criteria, such as the source of the money or the goal for the money.
  • As investors we approach money with preconceived ideas and tend to pay more attention to info that supports our opinions and ignore everything that contradicts. The hindsight bias is where investors believe that the beginning of an event (such as a market correction) was obvious and predictable.
  • With the Gambler’s Fallacy, an investor falsely believes that past events will affect future events. Investors falsely believe that if the stock market or a portfolio has increased over a long period of time, that it can’t possibly continue.
  • In a nutshell, herd behavior is when individuals mimic the actions of a larger group, whether rational or not.
  • Overconfidence is overly positive assessment of your own knowledge or your control over a situation. Confidence would be thinking that you have picked the right investments for your portfolio. Overconfidence would be thinking they are the right investments and that what you select will remain the best indefinitely.
  • Emotion causes an investor to overreact to new information. The availability bias causes investors to place more importance on recent information, making any new opinion biased toward the latest news.
  • Prospect Theory states that as investors we value gains and losses differently. According to prospect theory, losses have more emotional impact than an equal amount of gains.

Did you recognize one or more concepts in your behavior? If you are concerned that you may be making some detrimental behaviors or biases, feel free to write me at david@lexwealth.com, or call me at 859-225-2596. If you enjoyed the series and want to know when my article is written, click here for a free subscription and have them in your email inbox every Friday morning!