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10 behavioural pitfalls investors should avoid

Morningstar  |  27 May 2016Text size  Decrease  Increase  |  

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This article initially appeared on the Morningstar US website.


Successful investing is hard, but it doesn't require genius. In fact, Warren Buffett asserted that it's not so much raw brain power you need, but temperament "to control the urges that get other people into trouble in investing".

As much as anything else, successful investing requires something perhaps even more rare--the ability to identify and overcome one's own psychological weaknesses.

Over the past several decades, psychology has permeated our culture in many ways. In more recent times, its influences have taken hold in the field of behavioural finance, spawning an array of academic papers and learned tomes that attempt to explain why people make financial decisions that are contrary to their own interests.

Experts in the field of behavioural finance have a lot to offer in terms of understanding psychology and the behaviours of investors, particularly the mistakes that they make. Much of the field attempts to extrapolate larger, macro trends of influence, such as how human behaviour might move the market.

In this article, we'd prefer to focus on how the insights from the field of behavioural finance can benefit individual investors. Primarily, we're interested in how we can learn to spot and correct investing mistakes in order to yield greater profits.

Following are 10 of the biggest psychological pitfalls.

1) Overconfidence

Overconfidence refers to our boundless ability as human beings to think that we're smarter or more capable than we really are. It's what leads 82 per cent of people to say that they are in the top 30 per cent of safe drivers, for example.

Moreover, when people say that they're 90 per cent sure of something, studies show that they're right only about 70 per cent of the time. Such optimism isn't always bad. Certainly we'd have a difficult time dealing with life's many setbacks if we were die-hard pessimists.

However, overconfidence hurts us as investors when we believe that we're better able to spot the next hot stock than another investor is. Odds are, we're not.

Studies show that overconfident investors trade more rapidly because they think they know more than the person on the other side of the trade. Trading rapidly costs plenty, and rarely rewards the effort.