Why we make irrational decisions in investing

If you want to see the greatest threat to your financial future, go home and take a look in the mirror.- Jonathan Clements

The worst enemy of successful investing is ourselves-human nature. This is because we make dumb decisions: those that bring us short-term pleasure but long-term pain. If we can understand how we do this, we can become a better investor.

We have to understand is that we are not rational beings, we are emotional beings. We do the ‘wrong’ things even if we know all the relevant facts because:

  • We often follow rules of thumb and not logic.
  • We assume that whatever is happening now is likely to continue happening far into the future.
  • We explain events using our personal experiences and stereotypes instead of reason.
  • We give more importance to new information(“the news”) than to things we have known for a long time. The recent past seems much more important than the past 50 years.
  • We would rather have an answer, even if it is the wrong answer, than be left with a question.
  • We look for, and usually find what we think are meaningful patterns in random events.
  • We think we are luckier, more skillful, and more insightful than in fact we are.
  • We have a herd mentality, and we are overly influenced by what people are doing, even in the face of compelling evidence that this is contrary to our best interests.
  • We fail to understand statistics and probabilities.

Before making a new investment, whether it is stocks, bonds, cash or real estate, read the above and see if you are making a rational decision or not. It might save you a lot of money.

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