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How To Avoid Large Investment Losses

I am not sure if I remember a time when I felt that our country was as divided as it currently is. It seems that the root of divisiveness stems from political ideologies. These political ideologies have created a breeding ground for passionate opinions regarding the state of our country. These passionate opinions can lead people to believe that they should take action with their investments in accordance with their political beliefs. Unfortunately, in the past 24 years that I have been in the investment business, the biggest losses that I have seen investors make have been fueled by passionate opinions based on political beliefs. I believe this occurs because of bias. There are a few types of bias that lead to investment mistakes with investing. One type of bias that leads to investment mistakes is confirmation bias.

Confirmation bias is the natural human tendency to seek or emphasize information that confirms an investor’s existing hypothesis. Naturally, when we believe that we are right about something, we will seek out information that confirms what we already believe instead of being open to hearing other opinions regarding why we might be wrong. Today it is easier than ever to get constant doses of news that align with your current investment belief system.

An additional bias that can cloud the investment decision-making process is called oversimplification bias. Oversimplification bias seeks to understand complex matters with simple explanations. Unfortunately, with investing, there are so many variables that can influence the direction of the investment markets that it is nearly impossible to factor in all the variables that can influence performance. A good example of oversimplification bias happened in 2020. How many of us would have believed that 2020, during the midst of a global pandemic, would have been an excellent year for investing in stocks?

I find that the oversimplification bias tends to affect people who have had a high degree of professional success more than others. I believe this occurs with highly successful professional people because they have been able to accurately assess professional situations in the past with their reasoning skills and naturally believe that this should translate with investing.

A final bias worth mentioning is the bandwagon effect. The bandwagon effect occurs when an investor finds enough other people confirming their belief system to want to join the crowd. This can be especially dangerous because with the number of news outlets available today, it is easier than ever to find many people sharing the same opinion as you. Finding others who share your same opinion can be very comforting psychologically, but with investing it can be dangerous. It is dangerous because you usually can find just as many other people who believe in something different than your group’s beliefs which can alter the performance of various investments.

Being a strong investor takes very different skills than what is required in other aspects of life. For example, in many aspects of life, I believe that confidence is very important, but with investing, I will take humility over confidence any day of the week. Being humble enough to know that your political belief system doesn’t translate to investment returns and understanding that the herd you choose to listen to isn’t always right. Finally, being mentally strong enough to keep your emotions from influencing your investment decisions is an important skill to be a successful investor.

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