Investing is often just as much of an exercise in controlling your emotions as it is an application of your knowledge. After all, we’re only human – even if you have an incredibly prudent investment plan, your feelings in the moment can lead you astray.
So to become a better investor, you need to identify how mental traps can affect your decisions, and how to avoid them.
Read on to find out how to avoid two of those mental traps:
Herd behavior
Some of our deepest instincts tell us that there’s safety in numbers; so we’re naturally inclined to follow the pack. If “everybody is doing it,” we’re prone to think they possess some insight that we don’t.
This is one of the mental traps that’s dangerous in investing because it tempts you to make concentrated bets in the market. If there’s a “hot” stock, for example, you’ll be lead to think that everyone clamoring to invest has secret knowledge about its future performance.
The most basic tenet of investing is to buy low and sell high, but through herd behavior, you’re buying an investment while it’s skyrocketing, with no certainty if that will continue in the future.
Recency bias
Recency is our tendency to weigh recent events more heavily into our decision-making over events in the past. Although recognizing recent patterns can be useful, it becomes one of the mental traps when it leads to short-sighted investing.
The performance of the stock market is dependent on an infinite number of factors, and it’s mostly unpredictable in the short-term. Yet when stocks are moving upwards, recency bias will lead us to think that high performance will continue indefinitely.
You can avoid this by looking at long-term data, rather than slim slices of recent performance. If you’re invested in a well-diversified, long-term portfolio, you’ll realize that the best course of action can be to stay the course instead of chasing recent events.
Learn more about avoiding mental traps in investing
At LexION Capital, we strictly follow the numbers, and our clients avoid emotional investing through our bespoke long-term investment portfolios. If you’d like to learn more about how you can circumvent mental traps in investing, contact us today.
