Why Do Investors Make Bad Choices? – Bloomberg 04-09-14

Salient to Investors:

Cass Sunstein at Harvard said:

  • Economists know that if you invest in stocks, it makes sense to invest in a passively managed diversified portfolio of largely low-cost index funds, weighted toward equities, and add money as you get it – diversifying it as well – and keep the cash you need.
  • The first behavioral mistake is “availability bias”, or if something has happened in the recent past, people tend to exaggerate the probability that it will happen in the future. The stock market collapsed in 2008, and does not collapse very often, so in 2011 you should not have feared another meltdown.
  • The second behavioral mistake is “loss aversion”, or hating losses from the status quo far more than equivalent gains. Suddenly losing $10,000 is more stressful than the joy of suddenly gaining $10,000.
  • The third behavioral mistake is “probability neglect”, or focusing on worst-case scenarios, especially when emotions are running high, and not on the likelihood that such scenarios will actually come about.
  • Investors are prone to the “disposition effect,” or selling stocks too quickly when they appreciate in price and holding on too long when they have depreciated in price.
  • Many individual investors are overconfident, men worse than women.

Read the full article at http://www.bloombergview.com/articles/2014-04-09/why-do-investors-make-bad-choices

Click here to receive free and immediate email alerts of the latest forecasts.