James Saft at the Globe and Mail illustrates how an investor’s behaviour can be one of the biggest risks facing a successful investing strategy.
Here’s an excerpt from that article:
Investors hate two things above all else: losing money and missing out. The tension between the two, the fear of loss and the fear of doing less well than one’s neighbour, drives much behaviour in financial markets.
It is psychologically painful to lose money. Psychologists Amos Tversky and Daniel Kahneman demonstrated that losing a dollar is about 2.25 times more painful than gaining a dollar is pleasurable. Holding on during market falls is hard, and looking at a supposedly evenly distributed graph of returns does little to give the average saver comfort.
At the same time, humans are animals who naturally compare what they have to what others get, not just to what they had before. Go to a Wall Street trading floor the day bonuses are announced to see how this works out in practice.
This means that investors are sensitive not simply to how they are doing relative to their goals, but also relative to the Smiths down the street. This fear of missing out, and its flipside, pain at lagging, can cause investors to take on too much or too little risk if they observe the “stock market,” often wrongly conflated with an index, going up faster than their own holdings.
You can read the full article here.
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