Understanding Investment Behaviors

When it comes to investing, we often focus on numbers like interest rates, stock prices, and returns. But there’s another powerful factor that shapes our own success, our own behavior. That’s the idea behind behavioral investing. Understanding how our thoughts and emotions influence financial decisions, no matter how much data we have, our brains still rely on instincts and shortcuts, which could lead to irrational decisions. Today, I’m exploring two common categories of investment behaviors cognitive and emotional biases, and looking for looking at strategies to help correct them. The first category, cognitive biases, are systematic errors in thinking based on how people process and interpret information. One type is confirmation bias, which is a tendency to seek out and focus on information that supports what we already believe and ignore any conflicting evidence. This can lead to overconfidence and a failure to assess risks properly. Now here’s an example. Say you’re reading about a new electric car company and are convinced that it’s the next big thing. You’re going to follow every positive headline and scroll past reports about competition or risk the result. You build confidence, but not necessarily accuracy. Another type is anchoring bias. This happens when we rely too heavily on the first piece of information received, like a stock’s initial purchase price or a historical high. We then use this information as an anchor when making decisions. Now here’s what this might look like. Maybe you’re refusing to sell a declining stock until it returns to the price you’ve paid. Even if the business has declined. Anchoring keeps us stuck in the past instead of adapting to new information. Now let’s talk about emotional biases. Now, these types of behaviors are based on feelings and impulse rather than rational analysis. One type is called loss aversion. This is the tendency for the pain of a loss to feel more intense than the enjoyment of an equivalent game. Let’s say an investor has a goal of good long term growth for their portfolio. But instead of investing in a diversified one with higher growth potential, they invest in low risk assets with minimal returns. They could be missing out on building wealth due to their fear of losing money. And finally, there’s herd mentality, which is our tendency to follow the crowd. This typically is based on emotions rather than independent research. When everyone’s buying it, feel safe to join. When markets drop, we rush to sell. Have you ever heard of the acronym FOMO? That is the fear of missing out. FOMO is a powerful emotional driver of herd mentality because it pushes investors to buy at record highs just because everyone else is doing it, and often leads to regret when the hype fades. So how can we improve our investment behaviors? Believe it or not, the same principles that work for training a dog can help you train your investment habits too. Now stay with me on this. I know you might be thinking, how does a dog, how does dog trading correlate with training our own investment behaviors? When we got our dog Zouma as a puppy, we started training him right away. We had to have a clear training plan in place, not only teaching him basic commands, but also training him on how to behave in certain situations using repetition and discipline. Now here’s how that applies for strategies to improve investment behaviors. Just like you need to start with a training plan for your dog, you also need a financial plan that’s based on your goals, risk tolerance, and time horizon. Refer to it often when tempted to make impulsive decisions. Automate your investing. Build good habits through repetition and try using automated features like dollar cost averaging to make regular investments. Automating removes the emotion from the process process. It’s the financial version of practicing. Sit until it sticks. Another strategy is to diversify. Build a well diversified portfolio to reduce risk and minimize the impact of any single investment’s performance. You don’t want a dog that only knows one trick, and you don’t want a portfolio built on one stock, or one sector. And finally, talk with a financial planner who can provide guidance, ways to counter your behavioral biases, and assistance with the strategies that I just mentioned. While we didn’t have a professional dog trainer, I work with Zouma. Other dog owners might take their dog to one because they need help and that’s okay. Having a financial advisor helps you stick to your investment plan by staying disciplined and avoiding emotional mistakes. That’s what we do here at Centennial Wealth Advisory. If you’d like more information on various investment and retirement topics, make sure to subscribe to our YouTube channel.