The major belief is that investors are always these rational people that constantly take the perfect choices regarding their financial future. But the fact is that is not exactly true and, in most cases, the wrong decision prevents us from achieving our life goals.
Investors tend to be like every normal person – they tend to fall prey to human nature and the behavior that comes with it. Every person can be irrational, it doesn’t matter if we are talking about the financial world or any other area. It is carved in our genes to behave in a certain way when a number of conditions are met – as young investors we see that a stock or a company start to bring every ones attention and you hear how everyone is making a huge amount of profit and you kind of feel that you are getting behind on what you can potentially earn.
What is the next thing that our irrational nature makes us do?
Yes, we unload all of our earned money into this amazing “deal” and after a short period of time, our investment is vaporized purely because we moved with the trend.
The Pattern Game
We all have the ability to discover patterns in every daily activity that we are doing. We are usually correct with our pattern recognition, but the case in investing is not the same.
The reason for that is the market and the stock prices do not follow a specific movement, on the contrary, they are random. There are some financial analysis that can give you information what will be the movement of the price if specific conditions are met , but still you can’t be 100% sure that the price will go in the predicted path, especially if we talk about the cryptocurrencies market where we know that their price behavior is pretty strange at times.
Also, remember that even if there is a well-established pattern there is always the chance that it can change and move away from the predicted movement.
The illusion that you can beat the market
Every investor has been in this situation – you make a couple of great purchases and you make a good profit out of them later. That boosts your confidence and you start to get way over your head, by thinking that you can beat the market and achieve all of your financial dreams in couple of good trading days.
Well the reality is that the investors who are stuck in this kind of “I can beat the market easily” mentality, are the ones that have the biggest financial losses.
If you think you can select the asset that will bring you millions of dollars during day 1 of your “trading” life, think again. The chances of you picking this kind of stock is almost 0. Successful traders rely on their skill achieved through experience and failures, and not on their luck.
Do not let the past get you
The next major error in our investment habits is that we think that past events are drawing the map for future events. Some irrational investors predict that if a specific stock price starts to fall it will inevitably bring future low returns, but it is actually the exact opposite.
Let’s take a Tesla stock that today you purchase it for $200. After several months the stock price falls at $50 and your friend purchases one as well. In 10 years, which one of you will achieve their financial and life goals first? That is correct – your friend because he bought the stock at a lower price point, which gave him $50 more return or saved him the same amount.
This irrational behavior happens because of “recency” – the tendency to overemphasize more recent data and ignoring older data even if it makes the whole picture way clearer. The worst side of recency is that the asset classes have this behavior of reverting their course over a period of 3 years. In other words, periods of low performance are followed by periods of high ones and vice versa. This is not always 100% accurate, but it gives us the opportunity to buy some of the bigger company’s stock at a “discounted” price and bear the fruits of our investment.
The fear of short-term loss
We know that there are 2 types of risks: short term and long term. The short-term is the one that usually we fear the most. It is that fearsome moment when we see that our investments lost 20%-40% in value over the course of a couple of years. Short-term loss is so badly accepted by most novice investors that it drives them out from investing at all. This was the case with the current market development with cryptocurrency and how the huge drop in the price from ~$20000 to $6000 made a lot of people scared to ever invest again in anything, because they lost all of their investments or a significant amount.
We tend to do this because as we said before this a human feature that is carved in our genes. Every human enjoys more the short-term success and instant gratification, but in the financial world focusing on the short-term is usually really bad decision. As we mentioned before we have to stick to our plan to focus on our long-term financial goals. A loss of 30% in a couple of years is usually followed by a 10% profit in the upcoming future. The worst part is that the estimated risk horizon of the average investor is around one year.
The excitement in investing is (not always) bad for you
While you are taking financial decisions, excitement can be a scary and a good feeling. Depending on your financial goals and your investment strategy, sometimes it is ok to be excited about certain investments, duo to the fact that you will be a smart investor and you will know what your Risk Capacity is. This knowledge will help you to take the necessary risks when it is applicable in order for you to achieve your current life goals. We advise that your investment strategy should be a mix between a small portion of “irrational” investing and “boring” investing, where you allocate your capital in assets that do not have big fluctuations and they bring stable yearly returns.
The idea behind this investment strategy mix is that usually most people are figuring out that they have to start to save they hard earned money and invest them pretty late. They do not have the time to aim for only “boring” investments if they want to achieve their life goals. They have to pick the correct assets where you can take a bit of risk, but get better returns, that will speed up the process of achieving your life goals.
Don’t be a sheep
We as humans are social animals. We love to associate with one another and we definitely love to share the same interests. These features are amazing in general, but in the investing world, they can be the most dangerous traits.
The Herd Mentality manifests in the financial world very simple – by word of mouth, media, and many more information sources.
Everyone is saying what the next big company or stock will be and you see that everyone is investing in it. It becomes like some kind of fashion, where if you do not “wear the newest clothes” you are left behind and no one will even look at you. The problem here is that unlike fashion clothes stocks and bonds are hard to manufacture fast enough to keep the demand satisfied. That is the reason why prices rise when it is trendy to buy stocks and they plumed when everyone decides that it is not cool anymore to own stocks. You have to be very cautious and think about this – if everyone is convinced that stocks are the best investing opportunity today that probably means that most of the stocks out on the market are already purchased. This leads to another conclusion – if everything is sold out that means that the current prices are high and future returns will be low because there is no one else left to buy these stocks. In order to see the prices, rise there should be a big number of future buyers and that is when the stock prices will be low and future returns high.
Accounting for our failures
Admitting that you’ve failed is hard for everybody. But if you think about it because we fail we manage to learn and learning from your mistakes can be very helpful when it comes to investing. Going backwards in your steps where you’ve purchases that stock in the peak of its performance and later the price dropped by 30% will give you the insights what you should not be doing in your future investing actions. You will fail many times during your financial goal journey, but if your account for your errors and you learn from them your results will get better and better the more experience you have.
We’ve examined what kind of investment behavior you should be aware of and avoid it at any cost if you want to succeed in the financial world.
After we’ve discovered all the investment sins, lets’ see how we can reverse them and transform them into our advantages.
By definition, Risk Aversion is such a financial behavior where the investor picks the lower return but more save stock, instead of choosing the one with high return and high risk.
Averting your Risk is something that you should be constantly thinking of, but the one factor that defines how “avert” your risk will be is your life and financial goals. If you’ve set this goal in your mind that in the next 5 years you have to by your dream car and you want it to be fully paid off your whole investment strategy can’t be 100% without risk. We advise you to discover your Risk Capacity first in order for you to understand if you are capable of handling a bit riskier approach in your investment strategy for you to achieve your life/financial goals. This kind of strategy requires a bit more investing experience, but we will try to guide you on how to discover potentially higher risk – higher reward assets that you can invest in.
In order for you to be prepared for such opportunities, we advise that you always have some liquid cash that is waiting to be invested. This way even if the market starts to go down and you see that your portfolio got hit with a 30% loss, your liquid money will provide you with the chance to purchase your initial investments or other assets that look pleasing, on a discounted price. By doing so you will be lowering your average buying price, which will reflect on your future returns.
Be (don’t be) boring in your investments
“If by any chance you find yourself excited about your portfolio that means you have to revisit your investment strategy. Investing strategies should be as boring as possible.” – that will be the advice of almost every experienced investor, but there is a time and place to be boring when we talk about investing, but also there is time for excitement if you implement it in the right place and time.
Imagine this scenario – you are in your early 30ties and one sunny day you realize that you have no investments and your life goals that you’ve always dream about (comfortable car, a house big enough for your family, etc.) are far from being reached. In this case, you cannot afford to be boring when it comes to investing (only people who started investing their money from their early ages can afford such financial behavior). You simply do not have enough time. You have to take a bit bigger(measured) risk when you design your portfolio so that your life goals can be translated into financial goals.
To avoid overconfidence, first, you have to recognize it. If the thought that you have picked the winner stocks of the century crosses your mind – think again.
Never, ever think that you can outsmart the market. There are dozens of professionals that have bigger resources than you and are working way harder than you. The probability to beat them is very small. Every once in a while, tell yourself that you are not smarter than the market, and the chances for you to find the next “big hit” on the market are small.
You should be paying attention to what everyone is talking about – take the recent events of the Cryptocurrency boom.
Everyone was talking about it and everyone was investing. The result was a skyrocketing new height of the price of Bitcoin. Shortly after the price went down and a lot of people who had put their homes, cars, and everything valuable at the pawnshop or in the hands of the bank, lost their investment.
You have to realize that usually, assets with high future returns are the most unpopular ones. If you’ve shared that you have invested in a new company and everyone around you has never heard about it – you are probably on the right track and the correct financial decision.
Overall, these are the major mistakes that an investor can make. By avoiding these mistakes and by following our advices on how to prevent them, you will probably have a better investment future and your road to achieving your life and financial goals will become way easier.