Ever thought about investing? Just give it a little thought . . .
Making your own investment decisions can be a tricky business. Emotion, bias and the ongoing roller coaster with returns (or losses!) means that DIY investing is not for the faint hearted. But if you are wanting to give it a crack on your own, here's a few of the most common mistakes DIY investors make, and what you should do to avoid getting caught in the same blunders:
Herding bias – Don't be a clickbait investor
It's tempting to simply copy people who seem to know more than yourself, but this can be a tricky path to take when investing. While it might seem attractive when a celebrity is investing in a certain company, it's always worth taking this information with a grain of salt. If you don't know someone's rationale for trading, you can't assume you know their real view on an investment.
The same is true if you hear about a hot opportunity at a BBQ - it's always best to do your own research instead of blindly following other people's advice. Of course, you can use the presence of professional investors or public excitement as part of your decision-making process, but be aware of possible hidden motives or herd mentality and don't let others dictate your decisions. It's safe to say if someone like Floyd Mayweather is trying to sell you on a cryptocurrency, his endorsement alone would not justify the quality of the deal.
Confirmation bias - Take a good look under the hood
Our brain has a tendency to focus on information that confirms our current views and discard that which challenges or contradicts. Most recently this has been brought to light during the Facebook privacy scandal, where Facebook filtered what users saw based on their existing viewpoints. This bias can also occur when investing. If you find a company you would really like to invest in for whatever reason - perhaps they produce a high-quality beverage you enjoy - you are likely to then give more weight to any information that confirms your current view (such as positive articles or endorsements) and ignore any information which challenges your view (like an inflated price for the shares). It's also possible that if you initially see a lot of positive support, that might lead you to overlook any negative material that you discover as you dig deeper.
A good way to avoid this type of thinking is to plan in advance what relevant information you need in order to make a good decision, and then make sure you are ticking all those boxes without letting information from one area influence another. Just because a stock has gone up over the past week, that doesn't mean you should automatically view the management as suddenly being more skilled in the long-term running of the business. Don't let short-term noise or your initial views distract you from making objective long-term investment decisions.
Endowment bias – Just because you chose it, doesn't mean it's good
There is a well-documented psychological bias about the value assigned to something by someone who owns it, versus those who don't. Unsurprisingly, the people who own an item tend to place a significantly higher value on it. This can lead to investors holding onto and selling stocks they own too late because they have an unreasonable view of the price.
A simple thought process exercise is to look at an asset you own, ignore any personal diversification or current cash constraints, and decide whether you would buy more at the current price. If the answer is no - it's possible your attachment of ownership might be obstructing your view on what a fair price is. Another way to think of it - how many used cars on Trade Me sell for the initial price which they are listed at? I would bet not many.
Our brains are tricky things to control and even the best investors sometimes see biases in their decision making, and usually after the fact. Next time you are considering piling into an investment after a celebrity, or refusing to sell at a price you would never buy more at, consider these potential pitfalls - you might just catch yourself and think again.