Are you overthinking your investments? We'd never advise you to make money decisions without some careful consideration. But according to the American Association of Individual Investors (AAII), even the most well-adjusted investors fall victim to mind games.
Confidence can be healthy. Who wants to doubt their own abilities or suspect that the pro they hired isn't one of the best in the field? Overconfidence, however, can lead to excessive trading and diminished returns. If you find yourself making hair-trigger investing decisions -- based on advice or your own inklings -- that tend to go poorly, give yourself a trading waiting period.
Fear of regret nips at the heels of those in the overconfidence camp. Investors who give too much weight to potential feelings often make poor decisions, such as holding on to losing stocks (to put off having to admit the boo-boo) or selling their winners too soon (to prematurely celebrate victory and remove the potential for defeat). How do you face this fear? With perspective, advises AAII: "Convince yourself that unrealized losses in your portfolio are the same as realized losses."
If you tend to cover your ears and say "la la la la la" when the talking heads deliver bad news about a company in your portfolio, you might be suffering from cognitive dissonance. The natural reaction is to ignore or discount information that conflicts with what you believe. Some people call this "ignoring the danger signs." Remove the emotion from your buy, hold, and sell decisions by writing out why you purchased a stock in the first place and reevaluate the reasons whenever facing an opposing viewpoint.
With the advent of instant information, many investors concentrate too much on the day-to-day and hour-to-hour portfolio goings-on, attaching a psychological anchor to a short-term situation. Remind yourself regularly that investing is a long-term process. Emphasizing short-term events over the long-term ones will only blur your investing objectives.
Similarly, concentrating on the short-term consequences of a potential loss or gain -- myopic risk aversion in shrinkspeak -- can shortchange your future. If you avoided putting any of your retirement dollars in the stock market (which can look downright stormy through a short-term lens), your retirement kitty won't even survive the ravages of inflation. Study history -- and historic returns -- and keep long-term considerations in your line of sight.
When one thing looks a lot like the other, the mind tends to take a mental leap and assume that two are nearly identical. Representativeness, as the shrinks call it, can be dangerous to your returns since a few similar characteristics of, say, a mutual fund, can be shared by vastly different investments. For example, two small-cap funds may boast similar returns, but the one that is classified as a "value" fund may actually have performed much better compared to its peers than the other. Avoiding costly shortcuts and looking at all available variables will help you find true gems.
