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Successful investing: how to stay on track
Find out in this article why it makes sense to stick to your investment strategy and why subconscious behavioral tendencies often contradict this advice.
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The main points in a nutshell
The main points in a nutshell
- We often procrastinate before looking into financial topics such as investing. This can be due to what is known as “self-control bias.”
- Even if we opt for a given investment strategy, it can still be difficult to follow it in the long term, especially during periods when the markets are fluctuating wildly.
- Following trends can tempt you to neglect your own investment strategy.
- Another behavioral phenomenon/tendency that can blow us off course is what is called “hindsight bias,” i.e., knowing better in retrospect.
- Test your knowledge at the end of the article.
Are you reluctant to invest excess liquidity even though it’s just sitting on your account and not earning you anything? You are not alone.
Rationally, you may be aware that investing this money could bring long-term financial gain. Often, however, we lack the motivation to invest our money in the future rather than spend it now – especially when we are still young.
And when we finally decide to invest, even very minor market fluctuations can be unsettling. Such situations lead to ill-considered actions – such as the hasty sale of an investment.
In many cases, these behaviors are due to unconscious internal processes such as the self-control effect, hindsight bias or herd mentality.
Why a lack of discipline puts your future profit at risk
Why a lack of discipline puts your future profit at risk
We make new resolutions at the start of every year, only to abandon them soon after. Sound familiar? Whether it’s to work less, eat healthier or even budget better – we often find it difficult to follow through on long-term intentions. This is especially true when it comes to money.
For those just starting out in their first jobs, other investments often take priority. For example, they are more likely to buy furniture for their first apartment, or a car, than to buy shares or start saving for their retirement.
Why do we do this? Behavioral psychology has identified one reason for this: according to the self-control bias, people tend to spend more money today than they do investing for the future. This is because we often lack the imagination to think about future events or simply the necessary discipline.
Financially, however, it would probably be worthwhile considering a more long-term perspective. Do you dream of owning your own home or starting your own business? Investing early and wisely could make your dreams come true much sooner than a vague New Year’s resolution.
Tips:
- Define your wishes, needs and financial goals such as owning your own home, a trip around the world, starting a family, or taking up a new hobby in retirement.
- Set a time frame by which you want to achieve them.
- Now determine an appropriate investment strategy to enable you to achieve these goals.
How market fluctuations trigger the herd instinct
How market fluctuations trigger the herd instinct
Imagine you’re on vacation and looking for a restaurant for dinner. There are a lot of people waiting in front of one restaurant, but only a few in front of the one next door. Which restaurant would you rather go to? Probably the first. “If so many people are waiting in line, the food must be excellent,” one might assume. Like most people, in this case you are subject to herd behavior, something which also happens in the financial sector.
Investors sometimes tend to underestimate market developments and fluctuations. There are no perfect predictions and new market situations can rarely be easily understood, let alone predicted.
People are subconsciously influenced or guided by others in their own environment, and also by those who are, in their view, professional role models. It gives them a sense of security, which can sometimes be false. This phenomenon partly explains why investors often buy stocks when prices rise and sell them again as soon as they start falling.
Consequences of herd behavior
Consequences of herd behavior
But beware: group-oriented behavior can be dangerous. Imagine you are in a small boat with five other people. If everyone suddenly moved to one side, the boat could capsize. Something similar can be observed on the financial markets. Asset bubbles arise when investors panic buy stocks or bonds in bulk. The market can even collapse completely like it did in 2001 when the dot-com bubble burst and countless private investors experienced severe financial losses.
In order not to succumb to herd instinct, it can be helpful to evaluate your own risk profile. Investment strategies are suitable for an investor if they can sit out market fluctuations and not suffer financial hardship in the event of losses.
Herd behavior does not only happen in times of uncertainty. Trends or recommendations from public opinion leaders can mobilize people en masse.
Anyone who finds themselves in an uncomfortable investment situation in future should first focus on their own long-term strategy and then define a set of well-considered measures as necessary. The famous quote by the US major investor and author Warren Buffet goes even further:
Be fearful when others are greedy. Be greedy when others are fearful.
Tips:
- Do not react to every market fluctuation like many investors do, i.e., without considering it within the full context of your financial situation and goals.
- By acting too quickly, you would likely be disregarding the fact that investment strategies are geared to the long term.
- It is best to inform yourself regularly about trends and market developments.
- It is also a good idea to seek the advice of an expert who can explain market information and movements in the context of your portfolio.
Hindsight bias – we are always wiser after the event
Hindsight bias – we are always wiser after the event
“I knew it!” or “It was obvious that would happen.” When it comes to investments, it would be extremely lucrative to know how the market will develop in the future. Of course it is impossible to know in advance whether an investment decision is the right one. Nevertheless, people tend to claim in retrospect that they knew how a situation would turn out. Investors often fall prey to this phenomenon, known as hindsight bias.
Our memory adjusts our predictions to what we know now. As a result, people can no longer remember what they predicted in the first place. In retrospect, the outcome seems indisputable, almost as if things could not have turned out otherwise.
Tips:
- For each investment, make a note of the advantages and disadvantages you considered before making your decision. When you look back, you will then be less likely to misjudge how you acted.
It is obvious that we are subconsciously influenced by behavioral tendencies when investing. It is worth reviewing your own investment strategy regularly and recording important decisions in writing. Even if most investors choose a different path, this does not mean it is necessarily the right one for you.
Test your knowledge
Test your knowledge
Select your answer below and find out how others answered.
One of your friends understands the financial markets really well. One evening this person tells you and your friends about a stock that is currently “in” and that you should definitely add it to your portfolio before it’s too late. You do the same as your friends – you get out your smartphone and place an order. Which behavioral tendency have you fallen prey to?
A year ago Petra bought shares in a technology company. Since then, the share price has doubled. She congratulates herself on her excellent purchase. What behavioral tendency has Petra succumbed to?
Because a personal conversation is worth a lot
Because a personal conversation is worth a lot
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