Behavioral Traits That Could be Detrimental to Your Portfolio Returns

Investor Psychology and Its Impact on Investment Goals

The psychology of an investor plays a significant role in why they consistently fall short of their investment goals. The common saying that "investors buy high and sell low" is largely due to the behavioral traits that influence our investment decision-making. George Dvorsky once pointed out that despite the human brain's immense processing power, it has major limitations. These include cognitive biases that lead us to make questionable decisions and reach erroneous conclusions.

Behavioral Traits and Cognitive Biases in Portfolio Management

Behavioral traits and cognitive biases are detrimental to portfolio management as they hinder our ability to emotionally detach from our money. History has shown that investors often do the opposite of what they should when investing their money. They buy high due to greed and sell low due to fear. The most dangerous factor to our success as investors is ourselves.

Top Five Behavioral Traits Affecting Long-term Investment Goals

Confirmation Bias

Confirmation bias, a term from cognitive psychology, is a behavioral trait that describes how people naturally favor information that confirms their existing beliefs. Investors often seek information that confirms their opinions and ignore facts or data that refute them. This bias is a primary driver of individuals' psychological investing cycles. As investors, we crave affirmation that our current thought process is correct, and we tend to avoid contradicting sources of information.

Gambler's Fallacy

The Gambler's Fallacy is a common behavioral trait where we place significant weight on previous events, believing that future outcomes will be the same. Despite the ubiquitous warning that "past performance is no guarantee of future results," individuals often focus on past returns, expecting similar results in the future. This trait is a critical issue affecting investors' long-term returns.

Probability Neglect

When it comes to risk-taking, there are possibilities and probabilities. Humans tend to lean towards what is possible, such as playing the lottery. However, as investors, we often neglect the probabilities of any given action, which is the statistical measure of risk undertaken with any given investment.

Herd Bias

Humans tend to go with the crowd, a behavior often unconscious but related to the confirmation of our decisions and the need for acceptance. In the financial markets, this herding behavior drives market excesses during advances and declines.

Anchoring Effect

The Anchoring Effect, also known as the relativity trap, is the tendency to compare our current situation within the scope of our limited experiences. When it comes to investing, we often become anchored to a stock that has increased in price and shun those that lost value.

Making Better Choices

Everyone makes bad choices from time to time. The goal is to make bad choices that don't have an outsized effect on our plan. When it comes to investing, focus on the rules and your investment discipline. Do more of what is working and less of what isn't. Keep your market perspectives and behavioral traits in check. Most importantly, if you don't have an investment strategy and discipline you are stringently following, that is an ideal place to begin.

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