What's the matter with you and why is it messing up your
portfolio? The oft-cited greed and fear characteristics aren't the
only human emotions that get investors in trouble. Regardless of
whether you have an IRA, 401(k) plan, or taxable brokerage account,
there are a whole range of behavioral biases and traits that
destroy investment returns.
In my video titled, "
Individual Investors Underperform
?" I talked with Terrance Odean, a Professor of Finance at the
University of California at Berkley about the common behavioral
problems that afflict the average investor. Much of Odean's
research focuses on the trading patterns of individual
Before you can avoid counterproductive traits, you first need to
be aware of what they are. All investors - even professionals - are
prone to cognitive and emotional errors. Let's analyze some of
Pass or Flunk? Ron Grades a $1.2 Million Investment
Hindsight Bias (HB)
HB occurs when people see past events as predictors of what will
happen once again. As a result, the HB person likes to extract
historical data to prove the certainty of future outcomes.
Unfortunately, while history sometimes rhymes, it doesn't always
repeat itself verbatim.
Here's the problem: HB may cause investors to increase their
risk by overleveraging investments that have done well in the past,
but may not necessarily do well in the future. HB is a cognitive
EXAMPLE: A HB investor buys into mutual funds (Nasdaq:PPTAX)
with good historical performance expecting that history will repeat
itself. Sometimes it does, sometimes it doesn't.
Status Quo Bias (SQB)
People are generally not comfortable with change and as a result
they avoid making changes even if it means improvement. The SQB
investor prefers to make no choices or decisions because they view
it as too risky. What they fail to understand is that even the "no
decision choice", is still a decision.
People with SQB fail to explore new investment opportunities.
This can include unfamiliar but important asset classes like
commodities (NYSEARCA:GCC), global real estate (NYSEARCA:RWO), and
TIPS (NYSEARCA:GTIP). Additionally, they tend to keep investment
portfolios that may be higher risk or not precisely match their
goals. SQB is classified as an emotional disorder.
EXAMPLE: The SQB investor doesn't mind hanging on to money
losing stocks (NasdaqGM:QQQ) or funds because they feel comfortable
or familiar with these investments.
Regret Aversion Bias (RAB)
Have you ever been afraid to make a decision because you weren't
sure it was the right one? This is a common symptom of the RAB
investor. Sometimes their indecision ends up turning into a
decision of default.
Another mistake that RAB types make is they will buy an
investment and hold it for too long. This can even occur with
investments that have gone up in value. RAB types turn into
reluctant sellers because they're scared the investment they own
will increase in value after they sell it.
People dogged by RAB frequently engage in herding behavior too.
In other words, they feel safer in popular or widely held stocks,
mutual funds, or ETFs in order to avoid the possibility of future
Ultimately, before you can get your money right, you must first
get your mind right. The
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