Have you ever owned an investment (shares in a listed company perhaps) that you started losing money on? Did you feel a bit unhappy and then stopped looking at the investment even though the price continued to drop?
You are not alone. This is one of the tricks our mind uses against us when investing. Below we list some of the deceptions our minds use against all of us when we invest. We also provide some tips on how to avoid them.
The following information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs.
I don’t like losing
Do you often hear people say they hate losing more than they love winning?
Many studies have shown that most people tend to feel greater emotions from a loss than they do from a win. Scientists call this loss aversion.
If you have ever intentionally avoided doing something about a bad investment then you have come face to face with loss aversion. We all know it is very painful to sell an investment that realises a loss. However, that is the right thing to do if the money can be used for better investments. Unfortunately, most investors tend to hold on and wait for (or perhaps hope) their bad investments will improve.
Tip #1: It is better to realise an early loss on a bad investment and use the money for other better investment opportunities.
It’s gone up 40%, it must be expensive
Do you know someone who didn’t buy an investment because its price had gone up too much?
Perhaps you know people who start buying shares in a company because the price has gone down a lot recently?
Both are examples of a deception our mind plays on us called anchoring. This is when we anchor to a particular reference point such as a historical price when making a decision.
Retail shops use this against customers all the time. For example, they might increase the standard price of some items in a store but then increase the discount. Customers feel like they are getting a bargain at 50% off the higher standard price instead of 25% off if the standard price was unchanged.
Tip #2: A large up or down movement in share prices doesn’t automatically mean a company is expensive or cheap. Always work out what the value of the company is first and then compare it to the share price.
There are number of other tricks that our mind uses to trip us up when investing. Overconfidence is a common one where people tend to overestimate their own abilities. This may lead to avoiding investments in great opportunities or only focusing on investments in a very narrow field.
Sometimes this can be made worse by only talking to people who we know have the same opinions. Scientist even have a term for this calling it a confirmation bias.
Tip #3: Try to put aside any biases when investing and always keep an open mind.
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