As a seasoned financial planner with over three decades of experience in the industry, I’ve witnessed countless instances where investing common sense has clashed with our natural instincts. It’s a fascinating paradox that often leaves investors scratching their heads, wondering why their instincts sometimes lead them astray in the world of finance.
- Investing is emotional. One of the primary reasons why investing common sense can diverge from our natural instincts is due to the emotional nature of investing. Human beings are inherently emotional creatures, and these emotions can cloud our judgment when it comes to making rational financial decisions. Fear, greed, and herd mentality are just a few of the emotions that can influence our investment choices. This can lead us to make decisions that are based on impulse rather than logic.
- We are all subject to Cognitive Bias. Cognitive bias is the tendency to act in an irrational way due to our limited ability to process information rationally. We filter everything through our experience / background (that is all we know). This is why investing common sense can be contrary to our natural instincts… cognitive biases. These biases are mental shortcuts that our brains use to process information and make decisions, but they can often lead to irrational behavior in the realm of investing. For instance, confirmation bias causes us to seek out information that confirms our pre-existing beliefs while ignoring evidence to the contrary. This can lead investors to overlook warning signs or dismiss contrary opinions that challenge their investment thesis.
- We all have loss aversion bias. Loss aversion bias can cause us to feel the pain of losses more acutely than the pleasure of gains, leading to a reluctance to take necessary risks in our investment portfolios. Similarly, anchoring bias can cause us to fixate on irrelevant or arbitrary reference points when making investment decisions, rather than focusing on the intrinsic value of the investments themselves. An example, during times of market volatility, our natural instinct may be to panic and sell our investments (in a desperate attempt to avoid further losses). However, investing common sense tells us that selling during a downturn may lock in those losses and prevent us from benefiting from potential future gains when the market inevitably rebounds. Similarly, when the market is booming, our instincts may urge us to jump on the bandwagon and invest heavily in hot stocks or sectors. Yet, common sense reminds us that chasing after short-term gains without considering the underlying fundamentals of the investments can be a risky proposition.
In conclusion, while investing common sense may seem straightforward in theory, it can often be at odds with our natural instincts and cognitive biases. Recognizing and overcoming these psychological barriers is essential for investors to make rational, informed decisions that align with their long-term financial goals. By staying disciplined, avoiding emotional reactions, and adhering to a well-thought-out investment strategy, investors can navigate the complexities of the market with confidence and resilience.
In my experience working with an experienced, qualified financial advisor with whom you consult BEFORE making investment decisions will increase the odds of you picking and sticking with good investment plan that will help you pursue a place of financial peace. If you are not satisfied with your current advisor please reach out to us (schedule a call).
Dave Conley, CFP