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5 common psychological traps when investing

The human brain truly is a wonder. It is capable of complex mathematical tasks, sophisticated language and communication skills, and problem-solving abilities that are unparalleled in the animal kingdom.

Yet, while we may feel our minds are unique, many people often fall victim to the same psychological traps. These mistakes can have huge financial consequences in the investment world.

Let’s examine some of the most common mind-tricks investors encounter and how they could be losing you money on your portfolio.

1. Anchoring

Many people are prone to fixating on a particular reference point and basing all future decisions on that metric. This is called anchoring, and it can create a number of problems for high-net-worth investors.

For example, you may receive excellent returns on a company’s stock when you first invest, making you naturally inclined to favour that business in the future and ignore any negative indicators contradicting that opinion.

Remember that financial markets are fickle, so remain flexible to changing conditions and seek professional advice when considering large-scale investment decisions.

2. Superiority complex

Confidence can be a powerful weapon when investing, while overconfidence or narcissism may be your downfall. It is not uncommon for investors, particularly those who are on a hot streak, to believe they know more than independent financial experts.

“This better-than-thou syndrome isn’t unique to individual investors. Most institutional pensions and endowments routinely underperform a simple basket of low-cost index funds,” Rick Ferri, founder of Portfolio Solutions, told the Wall Street Journal.

Investors should always underpin their natural decision-making capabilities with help and guidance from investment specialists who can provide access to the right tools and market research.

Some investors can suffer from superiority complexes. A superiority complex can become a problem for investors if they become too confident in their own opinions.

3. Herding

Mob mentality is a common instinct in humans. There is safety in numbers, and banding together was a crucial survival tactic among our ancestors.

Unfortunately, following the crowd when investing can be a dangerous game. People are often quick to dump stocks if a company receives bad press or get caught up in a buying frenzy when a firm becomes trendy.

You should avoid the temptation to jump on the bandwagon. Instead, base your decisions on objective research and analysis of an investment’s true value.

4. Weather worries

Research from earlier this year showed institutional investors are influenced by arbitrary factors such as the weather when choosing to buy or sell stocks.

Case Western Reserve University scientists confirmed sunny skies encourage a buying mentality, while cloudy conditions are more likely to make investors abandon their investments.

The researchers said that while it was well known retail clients are prone to psychological biases, it was surprising that sophisticated professional investors were equally susceptible.

5. Loss aversion

Studies have shown that a loss is twice as intense, psychologically, as a gain. This creates an interesting behavioural habit in humans whereby we try to avoid losses at all costs – and beyond any reasonable justification.

Investors often hold onto stocks that have plummeted in value, with the hope that they will eventually come good. Often, this is wishful thinking and admitting defeat would enable you to reinvest the money elsewhere.

Understanding when to cut your losses is a crucial skill for investors who want to optimise their portfolio and achieve the best returns.

Overcoming psychological traps

No one is perfect, and it’s likely that all investors suffer these and other psychological traps when making big decisions on how to protect and build their wealth.

The key is to partner with independent industry experts with the skills and experience to ensure your investment choices are based on the best research, analysis and administration support.

To learn more about Affinity Capital’s range of services for professional investors, please contact us today. 

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