Monday, August 12, 2013

Know your investment bias

I have posted about investment psychology before and particularly how you often need to follow your instincts rather than listen to the noise around you.  Conversely there are times when you need to dampen the impulse to act straight away and to think about actions before you take them.

We all have our own individual psychology and the way in which we approach everything.  This is a function of our experiences and our upbringing. Some people are risk takers and others are not, some people like particular things that others wouldn't touch with a 10 foot pole.

Why is this important?  Knowing what makes you tick is important in investing because you know where your biases lie.  Biases are not always a bad thing but it often makes us over-cautious or over-confident with respect to certain issues.  Knowing your own psychology allows you to make more thought through decisions.  When you make a decision you want to be comfortable with the fact that you are not, for some quirk of your own psyche, making a bad one.

Investment bias can cover a variety of situations

Investment bias can cover such a broad spectrum of different activities and ways about thinking about things that it is impossible to list and name all of them.  Here are a few personal examples of my investment biases.  Think about whether you have any that are similar or perhaps completely different:

  • I inherently distrust internet / tech stocks
    • Why?  I started to get interested in investing around the time of the tech boom in the late 1990s and early 2000s when we were looking at a 'paradigm shift' into a new era.  Things were not trading on current fundamentals but rather on where things were going to be.  I then saw the crash and everyone fall back to reality and from then on have been completely distrustful of anything internet or tech related
    • How does this impact my investing? As a result of this bias I refuse to go near anything tech related.  This means that I avoid things that seem genuinely crazy and overpriced such as the Facebook IPO however it also means that I avoid tech companies that are actually making money and have a proven earnings stream
  • I really really hate tipping good money after bad
    • Why? I got burned with the first stocks that I invested in.  I actually started investing just before the GFC and as stocks I liked started tanking I invested on the way down.  Some of these stocks are just about breaking even today, years later.  
    • How does this impact my investing?  I think I trust my judgement less than I should.  Often I will invest in a stock and then watch it go down.  I objectively know that I should be putting more money in (especially when very little has changed) although I find it really hard to do so
  • I am really bad at selling stocks
    • Why? I think I inherently view selling stocks as a 'negative savings' type activity.  I know this is silly as I am not going to spend the money but rather re-invest it, but because I always have surplus cash, if I want to go into another investment I never have to sell a stock
    • How does this impact my investing?  I hold onto stocks for too long.  Stocks that are winners, I do not take the winnings and re-invest it in better opportunities and stocks that are losers I don't cut my losses and look for other opportunities.
There are plenty more examples I can think of like this but as you can see they make a big difference to the way I invest.  I'm sure you have examples of your own (post them below...I'd love to hear about them!)

Controlling your bias, or at least being aware of them, can make you a better investor

I know my bias and I think deep down most of us know what we are good and bad at when it comes to investing and general decision making.  If you know this you can assess what you are doing every time you make a decision.

I think one of the harder things to do is assess when our bias leads us to a 'do nothing' situation which is what many of mine relate to.  In this case we have to actively force ourselves to think whether this 'do nothing' situation is the best outcome or decision.

If you think about your bias in a rational sense and know what you are doing and why you are doing it, you can often moderate this behaviour and change the way you act. This can make you more objective and less emotional when you invest which is always a good thing.

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