John Labunski - Behavioral Finance: 3 Mistakes to Avoid

by John Labunski The Broke Leading the Broke

Investing in what you know is the first rule to avoid making the worst mistakes. Those of you who have already read some of my articles know how fundamental investment awareness is. Often, however, too much awareness can lead to excessive trust in ourselves, or on the contrary our emotions can put us in crisis so much that we remain paralyzed in the face of what is the vast world of investments. So let's see 3 mistakes in "behavioral finance" that you shouldn't make:

1) Overconfidence

It is a widespread attitude that consists of an excess of self-confidence, which very often determines wrong investment choices, determined by clichés, memories and external points of reference such as, for example, the past experiences of friends and relatives.

In investing, the bias of overconfidence often leads people to overestimate their understanding of the financial markets and ignore data and expert advice. This results in reckless attempts to time the market or make risky investments without diversifying , thinking they are acting "safe". There is no perfect formula for "overconfidence" but being aware of the danger helps to be cautious.

2) Analysis paralysis

Almost the opposite problem with respect to overconfidence: to remain paralyzed because in difficulty in considering all the various options. A problem common to many people who end up getting stuck investing, as if they are suffering from paralysis. Choosing the do-it-yourself method is not the right choice if you do not have a broad enough knowledge of investment strategies and above all it will seem very difficult to define your goal and therefore understand what is most important to you. But standing still is not the solution! Liabilities can make you miss several opportunities and the cost to pay is called inflation ( see article ).

3) Familiarity bias

One of the most common cognitive distortions among investors is the familiarity bias, which is the positive bias towards what we know best. Investors tend to trade stocks they are familiar with. It's comforting to have your money invested in a business you know - a bias of familiarity that has a strong influence on what you buy. A perfect example could be government bonds or savings books, which are among the preferred choices by United State, almost out of habit, even in cases where they do not prove to be the most suitable solution.

Chip Heath and Amos Tversky, an American academic and an Israeli psychologist respectively, have shown in a series of experiments that when people have to choose between two bets, they will choose the one they are most familiar with, even if for the latter the odds of winning. are inferior! Just because you know that particular thing well doesn't mean it's the best, you always need to look beyond your "comfort zone".

When it comes to financial instruments it is not possible to choose one that is valid for all seasons: it is essential to rely on a trained expert , so that your choices are supported by the knowledge of the facts that only a professional, who deals with finance 24 hours out of 24, it can instill you. The consultant will help you choose a direction, and take that leap that, with his support (and over time) you will not regret having taken.

Posted by: John Labunski