The theory of Behavioral Finance has grown during the last 20 years or so. A study of this field will yield much functional information on the psychology of investing. As an investor you will be effectively prepared for success if you can identify the poor behaviors that lead to loss. As you are aware my work has been focused on helping investors and consumers avoid being victimized by scams, frauds and predatory sales tactics. The majority of this work is focused on the individual and the behavior traits that lead to victimization.
Most services or professional advisors seek to identify the scams and frauds in order to protect the potential victims; this unfortunately is much like prescribing aspirin for cancer. The reality is that victims subject themselves to the scam, fraud or predatory sales tactic. Even identifying the scams and frauds wouldn’t be a fulfilling solution to insulating victims. The only pure cure is helping the potential victim understand the psychological triggers that initiate the launch codes for the perpetrators of the scams and frauds.
Once you understand the behavioral traits that commonly create victimization you will be able to fully inoculate and insulate yourself from scams, frauds and predatory sales tactics. With this information and education you will be successfully identify all scams, frauds and predatory sales tactics with minimal effort.
Today let’s review a common psychological trait that hampers investors from consistent success. Overconfidence is the commonality for human beings to think we are smarter and more sophisticated then we actually are. Studies have proven that when people say they are 90% sure of something they are right only 70% of the time. You can remember a time when you were absolutely certain about something and then totally amazed that you were incorrect, remember? This overconfidence for investors’ shows up in the behavior of rapid trading due to the thought that we are smarter than the person on the other side of the trade. Rapid trading leads to unrecognized losses in the form of commissions, fees and taxes. In the end the annual returns are negative as the losses add up. The need for control is the behavior trait behind the overconfidence. If we are more active in our investments then we have stronger control and feel a sense of comfort that comes with full control. Unfortunately our inability to recognize the overconfident behavior leads us to losses.
Tomorrow we will look at the psychological trait of selective memory and how that impacts our investing behaviors.