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The investment mistakes we all make

Investment decisions can be an extremely hard thing to get right. Individual investors are faced with a vast array of investment decisions and options so choosing the right strategy can take a lot of time and hard work to get right, hence why so many turn to professional firms like Equilibrium Investment Management.

In the world of finance theory, there is an overreliance on the assumption that an investor will always act rationally and consider all the available information before making their decisions to invest, however, research highlights that investors are often not rational; Economist Richard Thaler, who recently won the Nobel Prize for his work on behavioural economics, has theorised that people have a natural inability to control their impulses when it comes to financial decisions. Add into the mix the flurry of constant economic information available, investors can be forgiven for hesitating and doubting the decisions they make. Even though it is impossible to sum up how to get these calls right, here are some of the simplest flaws we possess when faced with investment decisions.

Memory Bias

While research should be undertaken before any investment decision, it is difficult to not be swayed by recent information. Investors often give too much weight to recent experiences which may steer them away completely from what was believed beforehand. It is important to keep perspective and take a long-term view in this respect.

Overconfidence

Overconfident investors have been found to overestimate their knowledge and its reliability, underestimate the risks and exaggerate their ability to control events. The behaviour that stems from overconfidence can lead to speculative market bubbles, like those seen in 1999 with technology and the crashes in 1987 and 2008.

Hesitation

This occurs when investors are too slow to react or update their thinking when given new information. The fear of getting a decision wrong and making a loss means investors could hold on to a falling investment, but can also miss out on potential returns if they are too hesitant.

Loss Aversion 

People do not behave rationally when facing loss, or when they make a profit. Investors place different weights on gains and losses, with investors much more distressed about prospective losses than they are made happy by potential gains. Research indicates that investors often play it safe when protecting gains, but when faced with losing money can take riskier decisions that are not in line with their risk tolerance to avoid loss.

Regret

Investors who are holding a falling investment can be reluctant to sell at a loss to avoid feeling the pain and regret of having made a bad investment. It is this fear of regret that can lead to investors holding onto to a losing investment too long in the hope that it will become profitable, or even sell too soon to lock in profits in case they turn to loss.

Financial Amnesia

As we have seen, investors are constantly dealing with one form of bias over another. This is simply how human nature works and we can be very impressionable, especially when money is at play. However, it is crucial to keep in mind past investment mistakes as well as successes.

 

Whilst investments can still fall as well as rise, relying on the services of a qualified and professional investment manager can help to remove some of the emotional biases involved in investing. Equilibrium Investment Management’s committee face such decisions every day and do the hard work to ensure that behavioural biases don’t impact your potential investment returns.

The content contained in this blog represents the opinions of Equilibrium investment management team. The commentary in this blog in no way constitutes a solicitation of investment advice, investment returns are not guaranteed and can fall as well as rise. This blog should not be relied upon to make investment decisions and is intended solely for the entertainment of the reader.