BLOG: How human nature can make DIY investing a no-win situation
As a result, the biggest investment errors come from psychological rather than informational or analytical factors. The psychology of investment contains many separate elements, which usually lead to poor investment decisions.
Greed is a powerful characteristic, which can cause individuals to ignore caution, logic, risk aversion, prudence, and memory of painful past experiences and a host of other sensible behaviours.
While such recollections could theoretically keep investors out of trouble, greed can lead people to pursue investment strategies that they hope will provide high returns, without high risk.
People will pay inflated prices for investments that are in fashion hoping that further appreciation is left, only to see their investments decline in value.
Logical decision-making should form the cornerstone of an investor’s thought process. The purpose of investing is to make serious decisions and returns, while watching for things that might trip us up. Inadequate scepticism helps us make poor decisions and ultimately lose capital.
The classic post-mortem of financial catastrophes often includes the phrases “too good to be true” and “what were they thinking?”. What exactly makes investors fall for these delusions is usually a failure to learn from the lessons of the past.
When similar circumstances occur again after a few years they are trumpeted by a fresher generation of investors extolling the wonders of this new infallible investment. Hope springs eternal, usually over logic.
- Herd Mentality
Human beings exhibit a common tendency to feel safe in groups. Nowhere is this more evident than in investment behaviour. The pressure on individuals to conform and the desire to get rich can allow the unwary to drop their guard and join the latest fad or investment bandwagon.
Those that do not initially share the consensus view can feel left out, reach the point where they feel they are the odd one out, and then join the rest. Think back to the tech bubble – some investors made a fortune and many more lost almost everything.
Generally in life and very often when it comes to investing, people become disillusioned and unhappy at the thought that others might be doing better and making more money than they are.
If you managed to make 6 per cent, which is no bad thing, and your friend made 12 per cent, don’t let yourself be influenced by the destructive power of envy. You might do better than your friend next year.
Achieving solid returns in good years and suffering smaller losses in bad ones is no bad investment philosophy. Those investing without ego will invest without exhibiting risky behaviour and be cognisant of how much they don’t know, while keeping their egos in check.
It isn’t a glamorous path to follow, but it demonstrates a prudent and logical approach; after all, investing shouldn’t really be about glamour.
Human beings are sensible and logical beings with the ability to make sound decisions in many situations – unfortunately, when it comes to investments, things can take a nasty turn. They hold on to convictions for as long as they can, but when the psychological and economic pressures become too great, they jump on the bandwagon – which often takes them in precisely the wrong direction.
To be a successful DIY investor one has to be disciplined. If you’ve tried and failed, you’re not alone. In fact, one could say you’re only human.