Emotions can play a major role in your investing success. Its human nature to have feelings heavily influence your decision-making, especially when your hard-earned wealth comes into play.
You can’t eliminate emotions from investing – in fact, you need to be in tune with them to determine your risk tolerance and goals. Your sentiments do present a danger, however, when they become emotional biases and cause you to think irrationally.
Here are some of those common emotional biases in investing, and how you can eliminate them:
Loss aversion
We’re hardwired to notice the possibility of a loss far more than a gain. In investing, this is one of the emotional biases that rears its ugly head when there’s volatility or dips in the market.
A long-term investment plan often should involve riding out short-term ugliness in the market for to achieve your goals over the long-run. This is easier said than done, however, because loss aversion can tempt you to ignore your financial compass and sell your investments.
To avoid loss aversion, it can be helpful to revisit your Investment Policy Statement, and to focus on concrete long-term goals. Although a short-term loss will feel painful in the moment, you can rest easier knowing you’re still on track.
Recency bias
Our minds are also trained to notice recent trends and assume that they’re more likely to happen in the future. This can be a dangerous assumption in investing, both in good or bad times. In good times (when your investments are doing better than usual), this bias can tempt you to pile more of your wealth into them. In bad times, you’ll be led to think your investments will continue losing indefinitely, and sell out of them.
Either way, you’ll be fooled into believing you can predict trends that are actually anything but certain. While long-term data is a core part of smart investing, attempting to forecast short-term trends is more akin to gambling.
Overconfidence
There’s a fine line between having hubris and healthy confidence, especially in investing. Having the confidence to withstand inconsequential movements in your portfolio is one thing, but believing you’re the next Warren Buffett is an entirely other manner. Unfortunately, studies suggest we gravitate to the latter. You can buck this trend by sticking to your investment plan instead of falsely chasing more wins in the short-term.
At LexION Capital, we base our investment decisions strictly on the math and science of the markets. We can help you avoid emotional biases in order to achieve your long-term financial goals and needs. If you’d like to learn more, start a conversation with us today.
