LexION Alpha Perspectives

Why You Should Avoid Cognitive Biases in Investing

“If you cannot control your emotions, you cannot control your money.” – Warren Buffett

Much of our psychology – and the resulting choices and behaviors – stems from a time when we foraged for food and when lions were a real danger rather than an interesting exhibit at the zoo. While we can still thank this hardwiring for keeping us out of actual harm, more often than not, it no longer applies in the modern world where we can order meals from our smartphones.
This is a psychology truism when it comes to investing, too. Mix the heated emotions behind money and the complexity of investing, and you can have a psychological recipe for disaster.
For instance, the overconfidence effect is a deep-seated mental bias that can innocuously rear its ugly head when your investments are doing well. This is one of the most common psychological traps when it comes to investing. It’s what makes smart investing so difficult, even for wise and capable people.
When your investments are on an upswing, it’s easy to become overly confident in your decision-making, and throw your long-term goals out the window in the process. Overwhelming research shows that even most professional money managers are likely to become overly optimistic in the belief that they can beat the market after they see high returns.
This very flawed thinking often ignores the most basic tenant of investing: buy low and sell high. Most investors learn an expensive lesson when they become overconfident and buy more stocks at an unnecessarily high price while missing a majority of the upward market momentum. They ignore diversification, make a concentrated bet with their wealth, and are often sorely disappointed when the risky gamble doesn’t pay off.
Look no further than international stocks, which saw double-digit percentage gains every year between 2004 and 2007. Almost everyone would gain some confidence in their decision-making with these investments in their portfolio. If you allowed this hubris to sway your decision-making, and poured more wealth into international stocks, you’d be sorely disappointed to say the least when they lost more than forty percent of their value in 2008.
Successful investing can require a great deal of discipline and contrarian thinking. Quite simply, good investing often feels lousy. Making those decisions, over and over, to go against the crowd and against one’s own emotions can be difficult.
As a LexION Alpha investor, you can benefit from a rational investment plan that attempts to ignore emotional decision-making.