According to a 2011 article in the London-based Telegraph, the Titanic disaster could have been avoided.
But First Officer William Murdoch waited a full 30 seconds to take action.
When Murdoch was warned that an iceberg had been spotted in the Titanic’s path, he waited to change course. As a result, the world’s most advanced ocean liner, 1,496 lives, disappeared beneath the waves.
What should have been a rational decision ended up being one of the most infamous maritime accidents ever.
Something in his head got in the way of doing the right thing.
You’ve heard of someone being unable to get out of their own way, right?
It’s when people let their emotions or biases get in the way of making good decisions. Well, the same phenomenon can be found in the world of investing.
Get Out Of Your Way
“The investor’s chief problem – and even his worst enemy – is likely to be himself.” – Benjamin Graham
At the heart of behavioral finance is the idea that investors tend to let emotions get in the way of sound investing. Behavioral “biases” explain why most investors act irrationally and let their feelings prevent good decision-making that can end in financial disaster.
Traditional economic theory assumes that individuals act rationally, consider all available information in decision-making, and that markets are efficient.
When it comes to investing, individuals DO NOT act rationally and DO NOT consider all available information when making investment decisions.
Too many investors act on their emotions and consider little information during decision-making. They let their biases get in the way of reasoning and often regret making investment decisions.
These are four of the most common biases that cloud individual investment decision-making:
Fear of loss
Bias #1: Overconfidence
Overconfident investors believe they have more control over their investment and its performance than they actually do.
They overestimate their abilities to identify successful investments. Even experts suffer more from overconfidence than the average investor.
Overconfidence prevents investors from considering all available data and making sound investment choices.
Bias #2: Fear Of Loss
The fear of loss prevents some investors from foregoing potential payoffs. Fear prevents investors from taking calculated risks that could pay off well.
And it’s one of the more common biases investors face. We’ve all made bets and lost, causing us to hesitate before reinvesting.
For example, if faced with a choice between receiving $100 or taking a 90% chance of winning $1000 (and a 10% chance of winning nothing), a person with a fear of loss would take the $100 rather than risk losing, even if it meant missing out on potentially receiving $900.
Bias #3: Herding
Related to the fear of missing out (FOMO), herding is the compulsion to follow what everyone else is doing.
This is how fads and “hot” investments are started.
Like wild animals, investors find comfort and safety in following the herd. It also leads to market bubbles and a cop-out from individual investors by blaming everyone else and not themselves.
“Watch what everyone else does – do the opposite. The majority is always wrong.” – Earl Nightingale
Bias #4: Availability Bias
Availability bias is lazy fact-gathering. Instead of researching or digging, we rely on information – social media feeds, news alerts, buzz, or whatever else is in front of us.
That’s why what they hear and see in the news, social media, at work, and coffee shops has more effect on investor decision-making than any sound economic fundamentals.
On your next investment decision, ask yourself:
Do I have the courage to do the opposite of what everyone else is doing?
Am I making this investment decision based on what’s in front of me?
But just be sure to evaluate and set them aside before you push the “buy.”
Staying Rational In An Irrational World
Investing is filled with emotion and bias that can lead us astray. As Benjamin Graham wisely stated, an investor's worst enemy is often himself. Whether it be overconfidence, fear of loss, herding, or availability bias, we all let irrational forces influence our decision-making.
The key is awareness. By understanding these common pitfalls, we can catch ourselves when emotions start to take over reason.
When everyone else is panicking, we must have the courage to think independently. When facts seem unclear, we need to dig deeper. Rational decisions require mental discipline.
To learn more about Nighthawk Equity investing opportunities, click the link to schedule a call.