Common Detrimental Investor Behaviors

On a daily basis, we’re all faced with making a wide range of decisions as we go about our lives. From what we eat for breakfast to what we decide to do after work, decisions that may seem small in the moment have the potential to affect the outcomes of our day. The same is true of investing – at some point, we as investors will need to make decisions about our investments or our portfolio that could have long-lasting implications.

While it’s easy to think we’re able to make informed, rational choices, the reality is the actions we take are often influenced by a host of behaviors and biases. Sometimes, we may not even be aware of these behaviors, which can cause us to make poor decisions that negatively impact our long-term plans.

Learn about some of the more common investor behaviors and what you can do to overcome their influence.

Overconfidence: It’s not unusual to come across someone who thinks they’re better at something than they actually are. In fact, we’ve all probably been guilty of that at one point or another. Overconfidence is also commonly seen in investing, where investors can easily rate themselves as being above average at making investment decisions. When you feel overconfident about your investing prowess, you tend to focus only on the upside of investments, while underestimating the probability of poor outcomes. Instead of trusting your gut, take a more rational and fact-based approach to make sure your decisions are as informed as possible.

Hindsight Bias: Some psychologists refer to hindsight bias as the “I knew that was going to happen” effect. By falling victim to a hindsight bias, investors may become angry or regretful about failing to avoid what appears to have been an obvious outcome. This could cause you to make poor decisions about similar events in the future. Keeping track of your investment thoughts and processes can help you better understand how you arrived at a specific decision, minimizing the chances for hindsight bias to affect your outlook.

Regret: Similarly, investors often react emotionally after realizing they’ve made an error in judgment, and may let that regret cloud future investment decisions. This emotional reaction can potentially cause you to become more risk averse, or perhaps take greater risks, in a way that goes against your long-term plan. As with hindsight bias, taking a more fact-based approach with your investment thoughts and decisions can help you remove emotions like regret from the equation.

Short-Term Focus: More than ever before, technology provides us with instant access to news headlines and information, including our portfolio and investment performance. While this can make our lives more convenient, it also has downsides. For example, checking on our investments too often, in conjunction with following only headline-driven news, can lead to frequent trading and/or overreactions to volatility. It’s important to remember that investing is a marathon, not a sprint. Don’t let short-term events impact your long-term plan.

Hot-Hand Fallacy: In investing, the hot-hand fallacy is when we perceive patterns where none exist, and then take action as a result. The concept of a “hot hand” is taken from a study done by Gilovich, Vallone and Tversky on the performance of basketball players, who are often thought of as being on a “hot” or a “cold” streak of shooting. The study analyzed players’ shots in hundreds of games and concluded that the outcomes of both field goals and free throws were largely independent of the outcome of the previous attempt. When selecting a wealth advisor, looking only at a one-year return (or attractive returns for the past few years) could cause some investors to drop their current advisor in favor of the one on a “hot streak.” This can lead to dangerous assumptions and predictions, when investors should be focusing on the long-term track record instead.

These examples show that there are a number of different behaviors that can impact our investment decision-making without our even realizing it. That makes it important to be methodical and fact-based in our approach to minimize any detrimental influences and stay focused on your long-term plan.

Data sourced from Financial Fitness Group

This article was published in the Q2 2024 issue of the Bell Wealth Newsletter.