Sunday, 28 November 2010

Behavioural Risks

Sunday, November 28, 2010

Investment Madness

We are all prone to having psychological preconceptions or biases that make us behave in certain ways. These biases influence how we assimilate the information we come in contact with on a daily basis. They also have an impact on how we utilize that information to make decisions.

Our very own psychological biases have an impact on our investment decisions and affect our attempts at building wealth.
Psychological Bias
Effect on Investment Behavior
Trade too much. Take too much risk and fail to diversify
Pay too much in commissions and taxes. Susceptible to big losses
Become emotionally attached to a security and see it through rose-colored glasses
Susceptible to big losses
Want to keep the securities received
Not achieving a match between your investment goals and your investments
Status Quo
Hold back on changing your portfolio
Failure to adjust asset allocation and begin contributing to retirement plan
Seeking Pride
Sell winners too soon
Lower return and higher taxes
Avoiding Regret
Hold losers too long
Lower return and higher taxes
House Money
Take too much risk after winning
Susceptible to big losses
Snake Bit
Take too little risk after losing
Lose chance for higher return in the long term
Get Even
Take too much risk trying to get break even
Susceptible to big losses
Social Validation
Feel that it must be good if others are investing in the security
Participate in price bubble which ultimately causes you to buy high and sell low
Mental Accounting
Fail to diversify
Not receiving the highest return possible for the level of risk taken
Cognitive Dissonance
Ignore information that conflicts with prior beliefs and decisions
Reduces your ability to evaluate and monitor your investment choices
Think things that seem similar must be alike. So a good company must be a good investment
Purchase overpriced stocks
Think companies that you know seem better and safer
Failure to diversify and put too much faith in the company in which you work

If you want to read more regarding human psychology and how it affects our trading and investment, please read the book “Investment Madness How Psychology Affects Your Investing and What to Do About It” by JOHN R NOFSINGER

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