Success or failure when it comes to investing often comes down to our personal psychological traits, and the way we make decisions, rather than the actual quality of investments themselves. These traits can quickly lead us down a path to bad investment decisions.
It’s our state of mind, our emotional wellbeing and personal traits which can either help or hinder our decision-making. Just examine the way you “think” about investing and I bet you’ll be surprised by how you’re influenced by a range of different emotions, bias and experiences.
Some are good, but plenty are bad. Trying to rectify some of the more damaging traits can dramatically improve decisions and, hopefully, performance. How many of these are you guilty of?
1. Giving into fear and greed
Investing can be scary. Tensions can rise when markets unexpectedly gallop in either direction. Emotions cause you to flee a bear market or plunge head first into a bull market, acting directly counter to the investment adage of buying low and selling high.
Investment history shows that if we counter these emotions completely many bad investment decisions can be avoided. Counter cyclical investing is buying a quality asset which is undervalued in falling markets and selling when it becomes overvalued in rising markets.
It’s not trying to pick the very top of a boom cycle, but being happy to bank good profits and leave something left over for the next investor. Those fear and greed emotions are just so powerful but can be so destructive and often lead us into making irrational decisions.
2. Being overconfident
Making decisions about investing and making money needs confidence. But there is a line… and it’s a very sensitive line.
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People with an inflated sense of their own ability to make smart investments often take shortcuts and don’t fully think decisions through. Cue bad investment decisions. Having the discipline to do all the appropriate, thorough and objective, research before committing, no matter how confident you are, is critical.
All the legendary investors have been renowned for their research and the ability to not go ahead with an investment if its prospects didn’t match their study. It takes courage to overturn a decision when the facts just don’t stack up… but it can save a lot pain.
3. Looking backwards, not forwards
Investing is all about the future prospects of an asset. That it has a bright future and will provide good returns.
As the future is hard to predict we tend to look to the past for some guidance. That’s fair enough but many investors have a bad habit of dwelling on the past, and talking about market developments as if it was obvious what was going to happen.
The reality is that it’s never that obvious, and hindsight can be misleading. It’s better to focus on the current environment and some of the lead indicators providing a glimpse of the future.
The current residential property cycle is a classic case in point. A year ago historic data showed a booming market, particularly in Sydney, leading indicators were strongly predicting a slowdown.
4. Relying heavily on past patterns
Technical analysis is studying historical market patterns and using them to try and predict the future. As seasoned investors know, making any kind of prediction is impossible.
Yes history is a valuable foundation for investing and determining the credentials of a stock or property. But tracking past price movements to build patterns to predict the future is just one tiny element of a complete assessment.
Fundamental real life aspects (such as trading environment, management, the state of the economy, skill of management, etc) are extra layers which need to be added to the analysis if you want to avoid bad investment decisions.
5. Not admitting a mistake
Whether it be pride, hubris or stubbornness, there’s nothing worse than “marrying a dog”. An investment you were confident would succeed but hasn’t performed, been a disaster but you simply hang on hoping you’ll be eventually right.
As the losses mount you eventually sell, but the financial damage could have been significantly less if you’d admitted the mistake and cut your losses.
Objectivity, and understanding you won’t be right all the time, is the key to success. Make the hard calls and move on.
6. Doing mental accounting
Investors often fool themselves into thinking that they’re doing better than they are. It’s human nature. So it’s important to keep track of how you’re doing on paper, not in your head.
It always amuses me, for example, when people talk about how much they make on property deal. When you gently ask them whether they’ve deducted stamp duties, legal fees, agent’s commissions and council rates from the profit, the penny drops that the transaction costs are substantial.
Yes, profit is the difference between a buying and selling price, but minus costs.
7. Not adapting
We all have a natural aversion to change that can get in the way of successful investing. In order to be successful, you need to be able to recognise when things aren’t working, and adapt accordingly.
Nothing ever stays the same. Investment cycles constantly change, politics constantly change as does regulations, management and financial circumstances. These can all provide opportunities but only to those who not only recognise the changes and are able to adapt.
We’re not talking about knee jerk reactions to sudden changes. It’s an ability to embrace an understanding of change and to think of it as an opportunity rather than a threat. Then to adapt an investment portfolio accordingly.