A number of studies have shown that investor behavioral biases have an enormous impact on investment returns for the average investor. Given the emotional component of investing, it is important to recognize that, while we cannot avoid these feelings, gaining an understanding of common behavioral biases may help us avoid acting on these emotions.
Here are several investor behavioral bias that you should be aware:
Loss Aversion—While it is human nature to prefer investment gains over losses, some investors are particularly sensitive and fearful during periods of market uncertainty. The behavioral bias of loss aversion is simply the fear of investment loss that can ultimately lead to an investor panic selling at the worst possible time.
Herd Mentality—The herd mentality involves following an investment strategy based on the fact that everyone else is doing it. Investors can feel as though they are “missing out” on the next big investment opportunity as all their friends, neighbors, etc. are reaping the benefits of a “can’t lose investment”. The herd mentality was especially common in 1999 during the tech boom.
Performance Chasing—Simply put, performance chasing involves investing in those investments that have experienced favorable short term results with the expectation that they will perform similarly in the future. Given the cyclical nature of the financial markets, performance chasing is rarely a profitable long term strategy.
Regret—involves not making a necessary or prudent investment decision, as a result of not acting previously. While regret can occur under many different circumstances, it is really common for those who have a concentrated stock position. These investors want to (and know they should) diversify their concentrated stock position, but they are holding out for a specific price. The stock proceeds to decline 10, 15, 20, 30 percent. Now, the thought of selling this stock at a significant “discount” to prior levels creates regret, indecision and worry.