Updated: Nov 7
Have you ever been conscious of the process behind your investment decision-making process, rather than just trusting your gut? Unfortunately, your intuition alone may often lead you to lose a lot of money. Here are five common mistakes you might have been making in your investing.
1. This Stock Name Just “Feels” Right
Following your gut might actually just be a common psychological phenomenon. For example, people often over-invest in corporations with stock names that appear early in the alphabetical order. Google has capitalized on this tendency by changing its stock name to Alphabet so that it appears earlier on the list and catches more attention. From the “stock name fluency” theory, recent researchers have found that the easier a stock name is to pronounce, the more people tend to invest in it. What’s more, people also tend to invest more in companies that heavily advertise their products; but
higher exposure does not necessarily mean a higher return. You might think it’s safe to go with that gut feeling but trusting just your intuition alone may not always be the best choice.
2. Into The Unknown
People, especially beginners, tend to invest their money in areas that they are most familiar with. This results in a portfolio that is not properly diversified, which could mean you are taking on more risk than you should for the amount of returns one could rationally expect. Even though people know that exploring outside of their comfort zone will help them in the long run, they often stick to what they know for fear of risk. Although it is impossible to master knowledge in every type of industry, don’t let this distract you from venturing off. You can overcome this fear by doing your research and following advice from seasoned professionals.
3. Blind to The Red Flags
You might have seen several investors who keep supporting a company, or what the media refers to as hopeless prospects, even when its stock prices fall drastically. This behavior is called “confirmation bias” when an individual seeks out evidence that confirms one’s beliefs and ignores facts that disprove them. You may think you are immune to confirmation bias, but people often tend to become blind when their own stock takes a hit. Make sure you are well aware of the red flags and know when to stop. explicitly say what to stop. Ex; stop investing?
4. The New Trend
Many people are swayed with terms like “momentum” and “trend” as they make their investment choices. But just because a stock is suddenly famous, doesn’t necessarily mean you should invest. This is called “recency bias”, which occurs when investors put an emphasis on recent events and give less weight to those that have happened in the past. Recency bias skews perception towards short-term thinking, which might not always lead you to make the most rational choices.
5. Change Is Scary
The last bias is the “status quo bias”, which is the tendency to resist any change, even if it is financially optimal. Due to this bias, many investors tend to accept the current situation and make the same judgment time and time again. Some even hold onto their current stock and refuse to sell it despite the losses it generates. Changing your initial investment strategy may be intimidating and at times seem uncertain. But remind yourself that stock prices fluctuate every minute and that change is necessary.
The biases and mistakes introduced in this article are just some examples of many. If you want to learn more about other factors to be aware of, go read more about the illusion of control!