4 Ways We’re Wired to Make Investing Mistakes (and How to Overcome Them)

4 Ways We’re Wired to Make Investing Mistakes

 (and How to Overcome Them)

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Fact: The stock market’s general direction over the long term has been upward.

Over the past 15 years, Standard & Poor’s 500 index (which tracks 500 U.S. company stocks), for example, has returned an annualized 5 percent. That even includes the losses from the Great Recession—like 2008’s nearly 39-percent drop. With the current bull market running for nearly 10 years, stocks have clearly bounced back and then some.

So if the market has historically recovered from downturns and continued to make more money, why don’t investors do quite as well? Blame the brain and the totally normal psychological tendencies, like these common investment biases, that betray our better investing sensibilities.

Gambler’s Fallacy

This is the tendency to think that if something happens more frequently now, it’s less likely to happen again in the future. For example, you probably know that each time you flip a coin, you have a 50/50 chance of it landing on heads. But if you were to flip it four times, and it consistently landed on heads, you might think the odds of doing it again next time would be lower.

Not true. You still have a 50/50 chance your coin will land heads up because each toss offers the same chance. Past tosses do not influence future results.



A related investing saying: Bull markets don’t die of old age. Almost a decade into the current bull run, plenty of factors (political strife, slowing economic growth, rising interest rates) could help bring it to an end. But just because the market’s been mostly up for so long isn’t a reason to think it won’t be in the future. That should be good motivation to stay the course on your investing strategy—and keep your eyes on the prize (hitting your financial goals).

Loss Aversion
Nobody likes to lose. In fact, the pain of losing tends to be greater than the joy of winning. That’s why, as investors, we’re prone to try and avoid it, even if it means missing out on potential gains.

Consider the last bear (down) market: When the S&P 500 dropped almost 50 percent from October 2007 to March 2009, many people were, understandably, spooked by the fall. Perhaps they sold what they could or skipped investing altogether—and the pain of the loss lingered and kept them from getting back in and recovering.

The market, on the other hand, had an easier time bouncing back. The index climbed back up to the 2007 peak and has continued on to new heights ever since, gaining about 280 percent since the 2009 bottom. If you’d allowed loss aversion to rule your investing and sold in a panic—rather than accepting that some drops come with the territory of investing—you’d have missed out on those juicy gains.

Overconfidence

What’s wrong with being confident? Nothing—but a little humility can’t hurt either.

Overconfident investors tend to think that they can beat the market by trying to time it (or frequently buying and selling to attempt to maximize short-term gains). But smart investors know that they can’t possibly know everything. Even investing guru Warren Buffett knows he can’t beat the market all the time and advocates a passive approach to investing, often touting index funds for us regular investors.

Herd Mentality

You learned all about this bias in grade school. It’s the tendency for people to follow the crowd and do what’s popular, logic be damned. In investing, it’s why people sell perfectly good investments just because the rest of the market is down for the day.

A better move? Do you. Which often requires doing absolutely nothing. Once you set up your long-term investing strategy, all you have to do is stick with it and ignore whatever the masses are doing to move the market one way or another each day.