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There are many reasons why people don’t succeed in investing. Whether it’s information overload, impatience, a lack of necessary tools or simple bad luck, plenty of things can derail a good plan.
In most cases, though, it’s the investor who’s responsible for his or her own failure. We make decisions based on emotions and character traits that steer us in the wrong direction. The field of behavioral finance tries to make sense of the thoughts and feelings that compel us to make financial decisions that are not in our best interests.
The Academy of Behavioral Finance & Economics identifies more than 100 traits and tendencies that can lead to poor investment decisions. Among the most prevalent:
- Greed, or a desire to get rich.
- Fear of change.
- Failure to admit past mistakes.
- Preference for avoiding losses rather than making money.
- Fear of making the wrong decision.
- Overconfidence, or believing we know more than we actually do.
- Herd mentality — the tendency to mimic others in order to conform, coupled with the belief that a large group could not possibly be wrong.
- Failure to focus on relevant data while concentrating on minutiae.
- Belief that past experiences or outcomes, positive or negative, will occur again.
- Unwillingness to wait for a bigger payoff later, preferring to settle for whatever we can get now.
- Overreliance on the most recent information.
- Assumption that previous success was due to our own knowledge rather than simply a rising market.
- Looking only for information that validates our decisions or choices.
- Confusing familiarity with knowledge.
Since we as investors may not be aware of our own tendencies, how can you avoid these pitfalls?
One way is to put a structure in place for investment decisions — clearly defining what you’ll do and when you’ll do it. With a solid framework, the mind games that impair decision-making won’t sabotage your investing. Here are five steps to build such a structure:
- Know your investing goals.
- Create a written plan that spells out exactly how your investments will be managed. This plan is also called an investment policy statement.
- Design a portfolio that uses prudent methodology.
- Regularly monitor that portfolio.
- Rebalance the portfolio (as needed) based on the investment policy statement.
Having a structure like this to rely on when making decisions — even when tempted by irrational tendencies — can help improve the outcome for many investors.
So, have you been sabotaging your own investing success? If you’re not sure — or if you’re sure that you have been — a professional advisor can help you put a stop to unproductive behavior. If you choose to get help, look for a fiduciary investment advisor who always puts your interests first.
But even if you don’t work with an advisor, make sure you have a clear structure in place to help you make investing decisions and avoid the behavioral pitfalls that plague many investors.
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