Investing can be a bit of a rollercoaster ride, with ups and downs that can leave you feeling exhilarated or sick to your stomach. The key to success is holding on tight and not letting your emotions get the best. Emotional biases can cloud your judgement, cause us to make impulsive decisions, and prevent us from sticking to our investment strategy. Understanding the psychology of investing is crucial so that you can overcome these biases and make better investment decisions.
Here are some common emotional biases that can affect our investment decisions;
lOverconfidence bias: occurs when we overestimate our abilities and believe we are better at investing than we actually are. Overconfidence bias can lead us to take on too much risk or make impulsive investment decisions.
lLoss aversion bias: occurs when we are more sensitive to losses than gains. Loss aversion bias can cause us to hold onto losses longer than necessary or to sell winning investments too quickly. It's like being more upset about losing $100 than happy about gaining $100.
lAnchoring bias: occurs when we rely too heavily on one piece of information or an experience when making investment decisions. Anchoring bias can prevent us from considering new information or adjusting our strategy as the market changes.
lConfirmation bias: occurs when we seek information that confirms our existing beliefs and ignores information that contradicts them. Confirmation bias can prevent us from seeing potential risks or opportunities in our investments.
Now that we've identified some emotional biases that can hold us back let's look at ways to overcome them.
Develop a plan and stick to it
When investing, it's important to have a plan and stick to it. Consider your long-term goals, set a realistic investment strategy, and stay the course even when the market gets choppy. Remember the words of the great investor Benjamin Graham, who said, "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." You should never worry about the market fluctuations if you are confident of the underlying value of your investment options.
One great example of this is the investment guru Warren Buffet. He's famous for sticking to a simple investment philosophy: to buy good companies at a fair price and then hold onto them for the long term. By following this strategy, Buffet has consistently outperformed the market and built a massive fortune.
Stay diversified
Another way to overcome emotional biases is to stay diversified. This means spreading your investments across various assets, such as stocks, bonds, and real estate.
Diversifying your portfolio can help reduce any investment risk significantly impacting your overall portfolio. It's like having a variety of dishes at a buffet, so if one dish doesn't taste great, you have plenty of other options.
Seek out different perspectives
To avoid confirmation bias, it's important to seek out different perspectives. This means listening to various opinions and considering different angles before making an investment decision.
One great example is the investment firm Bridgewater Associates, known for its culture of "radical transparency." At Bridgewater, employees are encouraged to challenge each other's ideas and consider different perspectives. By doing so, the firm has made more informed investment decisions and achieved strong returns for its clients.
If you're feeling overwhelmed about your investments, consider reaching out to friends or family for support. They may also be able to offer a fresh perspective.
Take a break
Sometimes, taking a break is the best way to overcome emotional biases. This means stepping back from your investments and taking some time to clear your head.
One great example is the billionaire investor Ray Dalio, who practices meditation and mindfulness to help him stay calm and focused. By quieting his mind, Dalio can make better investment decisions and avoid getting caught up in emotional biases.
Here are more suggestions on taking breaks when investing:
lSet aside specific times for checking your investments. Rather than constantly checking your portfolio throughout the day, set aside specific times when you will check on your investments. For example, you might check your portfolio once a day or once a week. This can help you avoid getting caught up in the market's day-to-day fluctuations and make more rational decisions.
lEngage in activities that help you relax and clear your mind. Whether going for a walk, doing some yoga, or listening to music, find an activity that helps you relax and clear your mind. This can help you approach your investment decisions more calmly and focused.
lTake a vacation. If you're becoming too obsessed with your investments, consider taking a vacation. This can give you the time and space to relax, recharge, and return to your investments with a fresh perspective.
lWork on other projects or hobbies. If you spend too much time pondering your investments, consider working on other projects or hobbies you enjoy. This can help you take your mind off your investments and reduce the risk of becoming too emotionally attached to them.
Taking a break doesn't mean you're neglecting your investments. It means you're taking the time to make more informed and rational decisions.
Have a sense of humor
Last but not least, having a sense of humor when investing is important. After all, the market can be unpredictable and sometimes downright crazy. You can avoid getting too caught up in emotional biases by keeping things in perspective and not taking everything too seriously.
One great example is the legendary investor Peter Lynch, who famously said, "If you spend more than 13 minutes analyzing economic and market forecasts, you should have spent 10 minutes in meditation instead." By injecting a bit of humor into his investing philosophy, Lynch was able to stay grounded and avoid getting too caught up in the hype.
To sum it up
Investing does not have to be an emotionless endeavor; to succeed, we can use our emotions to our advantage. The trick is to overcome our emotional biases and make better investment decisions. We can approach it with passion and dedication; we can develop a plan, stay diversified, seek diverse perspectives, and take breaks to invite calmness and rational thinking. Investing can be a fun and rewarding experience if we put on the right mindset.
