Most of us want to achieve success, whether that may be at work, in our relationships, or our health. In the pursuit of success, we all experience moments of self-loathing and frustration that stems from nowhere other than from our own hands – we are, our own worst enemies. Success in personal finance is no exception.
Have you ever wondered, what is the biggest risk to achieving your financial goals? Is it geopolitics, inflation, the rise of crypto-currency, a property bubble? No. It’s your own mind.
You can invest is all the right things, minimise all your fees and taxes, and diversify most risks away, but if you fail to master your own psychology, it is still possible to fall victim of financial self-sabotage.
Our brain’s natural instincts, to avoid pain and seek pleasure, may be very useful to Fred Flintstone, but can be very harmful when making financial decisions. So how do investors overcome these biases? The concept is simple, yet will test even the most seasoned of investors.
Our ideas are so simple that people keep asking us for mysteries when all we have are the most elementary ideas. – Charlie Munger
Put in place a system, rules, and a set of procedures that will protect you from yourself.
Mistake #1 – Seeking confirmation of your own beliefs
Our brains are wired to seek and believe information that validates our own existing beliefs. We love proving to ourselves how smart and right we are.
Ask questions and actively seek the opinions of well respected people that disagree with your own.
The power of thoughtful disagreement is a great thing – Ray Dalio
Mistake #2 – Extrapolating recent events
One of the most common and most dangerous, recency bias – to believe the current market trend will continue into the future. Investors end up buying more of something that has recently increased in price, ultimately paying more for the investment.
The best way to avoid this impulse of buying high (aka FOMO), rebalance your portfolio. You effectively sell assets at higher prices and buying assets at lower prices – when one investment performs well, you sell some of it, and top up the investment that hasn’t done so well.
Mistake #3 – Overconfidence
Ask a room full of people to raise their hands if they are a better than average driver, and you’ll have 93% of the room raise their hand. As human beings we overestimate our own knowledge and abilities, which can lead to disastrous financial outcomes.
By admitting you don’t have an edge, you’ll end up with an edge..
If you can’t predict the future, the most important thing is to admit it. It its true that you can’t make forecasts and yet you try anyway, then that’s really suicide. – Howard Marks
Mistake #4 – Swinging for the fences
As tempting as it is to go for the big winners to fast track your financial wealth, the more likely you are to be bowled out, which also means it’s going to take you even longer to get back on track.
The best way to win the game of investing, is to achieve sustainable long-term returns that compound over time. Short-term noise is simply a distraction from Wall Street.
The stock market is a device for transferring money from the impatient to to the patient. – Warren Buffett
Mistake #5 – Home bias
We have a tendency to invest in markets we are most familiar with creating a ‘home bias’. For example, we invest in the stock market of the country we live in, we invest in the stock of our employer, or we invest in the industry we work in. This bias leaves us overweight in “what we know”, which can destroy our hard earned wealth in some circumstances.
Diversify across asset classes, regions, and industries. From January 2010 to October 2018, Australian shares returned 7.50% pa. International shares returned 12% pa, and US shares returned 16% pa.
Mistake #6 – Negativity
Our brains are wired to bombard us with memories of negative experiences. The amygdala – the fight of flight system in our brain, floods our bodies with fear signals when we are losing money. Think GFC – markets were plunging, investors panicked, selling down their investments to cash. The US market has tripled n value since the GFC, making up all the losses plus more.
1) Be clear on why you made a certain investment.
2) Invest today for the long-term but assume the market will collapse tomorrow.
3) Partner with the right financial adviser to act as your sounding board.
By failing to prepare, you prepare for fail. – Benjamin Franklin
These aren’t guarantees that you will be successful during your investing journey, but it will damn sure put the odds in your favor.
Source: Visual Capitalist, Wikipedia, Vanguard