When dealing with people, remember you are not dealing with creatures of logic, but with creatures of emotion. —Dale Carnegie
Dale Carnegie was an early 20th-century author. Born into poverty in Missouri, he went on to write several books, one of which could be considered the first-ever self-help book in 1936, How to Win Friends and Influence People, a bestseller that remains popular today. Though he was not a financial writer per se, the above quote remains timeless wisdom which is applicable to the investment world.
All too often, investors allow emotion investing to guide their investment philosophy at the expense of logic. The history of the stock market is rife with examples of emotion-driven investment bubbles. Eventually though, logic prevails, the bubble pops, and rather than learn from history, the next generation of investors seems eager to learn the same lesson with their own money. For evidence of this phenomena today, one need not look any further than the various YouTube stars dispensing investment advice in meme stocks such as AMC, GameStop, and whatever company they decide to pump for the day. It is reminiscent of a stunningly naïve comment I heard on CNBC at the height of the Dotcom bubble over 20 years ago, where a young day trader triumphantly declared that we’re in a “new paradigm” where “profits don’t matter.”
Ignorance is one of those words that in modern-day parlance has a negative connotation. However, ignorance simply means, uninformed; and the way one escapes being uninformed is to become informed. When one is informed, one has a better chance of making logical rather than emotional investment decisions. And as an informed investor, one can go forth and recognize some of the basic mistakes of emotion over logic, that if unlearned, can leave one poorer rather than richer.
With that in mind, I present FIVE of the more common mistakes that if uninformed investors make, may increase their investment risk.
- Following the herd: Or as I like to say, “it’s all good until it’s not.” Everybody loves to talk about their winners but ask about the losers and you’ll often get a navel gaze and mumbled “aww shucks” while they draw a circle in the sand with their big toe. Often the result of following the herd is to buy high and sell low. Remind yourself that it’s not just a question of whether it’s a good stock, but is it also valued correctly.
- Focusing on short-term performance: It is human nature to overweight the importance of what is happening right now and discount both past information and future possibilities. Get back into the long-term frame of mind. Be an investor, not a day trader.
- Anchoring: The tendency to base decision making on individual numbers such as a target stock price and deciding a stock should reach some level before you sell it, or if it goes lower and you have a loss, telling yourself you will hang on to it until it is a gain, which may never materialize. Remind yourself that benchmarks are often arbitrary in nature. Also, do not be afraid to cut your losses and redeploy your capital in a more constructive manner. Every day you continue to own a broken stock is another day of opportunity cost slipping through your fingers.
- Confirmation bias: The habit of only noticing information that affirms one’s beliefs and opinions, thereby immunizing oneself from the things one does not want to hear. To counter this, take the other side of your opinion and run it through a logic test. If you are a buyer, ask yourself if this stock is such a great buy, why would somebody be willing to sell it to me right now at this price? What might they know that I don’t know?
- Availability bias: The habit of overweighting easily available and/or recent information. When somebody is pounding the table on CNBC about how great a stock is based on a big contract win, recent earnings report, etc. that qualifies as easily available information. While this information may be true enough, remind yourself that you may have correct, but incomplete information. There is always more to a story.
This is not an exhaustive list. There are other instances when emotion can get the better of our logic in the investment world, but we shall save those for another post.
Written by author: Jarrod Jacobi | Senior Financial Advisor, AWMA®
*The foregoing content reflects the opinions of Van Hulzen Asset Management DBA "Van Hulzen Financial Advisors" and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.