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Watch out for these 4 common investing traps

Published on: November 22nd, 2019

Investing would be a whole lot easier if the markets moved in a rational, predictable fashion. Unfortunately, they don’t. Market activity is the collective result of individual investors’ decisions, and investors are not always rational.

Irrational actions are the focus of researchers who study behavioural finance, or the psychological analysis of how individuals make money management decisions.

These researchers have identified four common investment traps.

1. Fear of regret.  If we’re not careful, the fear of making the wrong decision can become so powerful that we avoid decision-making altogether. For example, we might keep too much investment money parked in cash, hold on to an investment long after it should have been sold, or automatically reject new ideas. Also, after an investment turns out to be a disappointment, some people never buy another.

2. Framing.  This is the tendency to divide our finances into distinct clusters and “frame” them by managing each cluster without regard to the others. Many people, for example, work hard at reducing their home mortgage while continuing to carry credit card debt at much higher interest rates. The rational approach would be to view their entire financial situation and then allocate money based on potential payback.

3. Availability.  Many investors have a strong tendency to buy whatever’s new and exciting — regardless of whether it’s appropriate for their portfolio or even a sound investment. One example is investing in technology: technology company stocks are often hot sellers, based on sentiment for the brand, the products or the management without due regard for the financial soundness of the investment or its role in the buyer’s portfolio. In addition researchers have found that stocks and mutual funds tend to experience a surge in popularity right after being featured on a magazine cover or television show.

4. Confirmation bias.  Investors who are open only to information that confirms their thinking are exhibiting confirmation bias. For example, an investor may never review or consider changing a favourite investment, even if it is no longer an appropriate choice.

It’s one matter to identify these traps, but altogether another not to be swayed by them — after all we are humans, not investing robots. If you think you might be susceptible to behavioural traps in your own attitudes to investing, professional advice can help. While we can’t make you any less human, we can provide an objective view of the investments and remind you of your goals and why your portfolio is built the way it is.

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