The Top 10 Reasons Investors Make Financial Mistakes

“You can tell a good putt by the noise it makes”Bobby Locke

These behavior or decision moments lead to poor investment decisions:

  1. Recency – Investors tend to believe that recent facts or events are the most important, ignoring longer-term narratives or trends.
  2. Myopic – Related to recency, this is a focus on short-term futures forecasts and is highly speculative.
  3. Selective memory  – This is the reason why few investors tell “war stories” about their big losses.  We actually make it a habit to keep the stocks that are worthless in value from new investors transferring in… as a friendly reminder how investment decisions that have gone terribly wrong really make a lasting impact on future results.
  4. Duration, anxiety, and pain tolerance – Psychologists know that a person can tolerate a great deal of anxiety or pain, but the longer the situation persists, the more likely he or she is to break or take action to avoid the discomfort.  This applies to both the loss-aversion pain of a negative investment and the prospective regret over failing to take profits.
  5. Assumption – Related to #1, this is the culprit behind both bubbles and unwarranted declines in sectors.  Investors see what’s happening and assume it will continue on into the future, just as it has in the recent past.  But, it almost never does.  We like to be cautious when the market seems to be euphoric and aggressive when investors have all but given up on the markets.
  6. Confirmation Bias – We tend to see the factors in a situation that reinforce our preexisting views – and then ignore contradicting facts.  This happens in all walks of life, especially in cementing political views.
  7. Sunk cost fallacy – The more we hold on to our existing views, the harder they are to give up.  Despite the facts, investors hold on to investments all the way to the bottom when the value becomes worthless.  The greater the size of the sunk investment, the more people hold on, even when the return on added investment appears not to be worthwhile.
  8. Availability Bias – We tend to give too much weight when information is easy to obtain.  Think about how many investment decisions you’ve made from one friend telling you how great an investment it was going to be.  Did they all work out in your favor? Or a headline story with the best investment of the year.
  9. Small sample illusion – We also call this cherry picking.  Clients are famous for investing less than four years, being down a little from their initial investment and then walking away from investing the rest of their working years because they think the markets are rigged.  This attitude is far from healthy to our ability to build wealth from the number one historical in building wealth over long periods of time.
  10. College Endowment bias – Experiments have shown that the brain will assign a higher value to something already owned than to a purchase that’s contemplated. Just because Warren Buffet or Harvard endowment owns an investment does not mean we should as well (Preferred Stocks are a prime example)

 In addition to self-awareness, aggressive saving and discipline can neutralize/limit the behavioral mistakes we all make.  In an unknowable world, we believe the best way is taking the long view – finding and holding high-quality companies that generate dividend income now and continually grow their dividends over time.  In our opinion, our strategic and disciplined approach is “therapy” for the behavioral finance mistakes caused by impulsive emotional investing.

Of course, past performance isn’t always a guide to future performance, but if you believe that history is important when predicting the future, then history tells you that investing in businesses is the best way to create wealth.  These Businesses are largely traded publicly and make up the American Markets.  We simply need to get control of our emotions, behavior, and decision making in order to mitigate risk.

 

Blake Parrish, CFP®
Senior VP, Portfolio Manager
Phone: (503) 619-7237
E-mail: blake@bpfinancialassoc.com

Certified Financial Planner Boardof Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.”

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