Investing is as much about psychology as it is about numbers. Behavioral finance, a field that combines cognitive psychology and financial theory, highlights that our emotions and cognitive biases often drive our financial decisions, sometimes leading us astray. This article delves into three key behaviors that sabotage investments, exploring why they happen, and how to avoid them. Understanding and addressing these behaviors can improve your investment outcomes significantly.
The Influence of Behavior and Psychology on Investing
Traditional financial theory assumes that investors are rational actors who make decisions based solely on logic and available information. However, behavioral finance challenges this notion, suggesting that emotions and cognitive biases heavily influence our financial decisions. Studies, such as Dalbar’s “Quantitative Analysis of Investor Behavior,” consistently show that average investors often fail to achieve market-index returns due to systematic deviations from rational behavior. Recognizing these biases is crucial in avoiding common investment mistakes.
The Three Sabotaging Behaviors
- Anchoring Bias
- Loss Aversion
- Herd Behavior
Each of these behaviors can significantly hinder your investment performance if left unchecked. Let’s explore them in detail and learn how to counteract their negative effects.
Anchoring Bias
Anchoring bias occurs when individuals rely too heavily on the first piece of information they receive (the “anchor”) when making decisions. In investing, this might mean fixating on an initial stock price, an analyst’s prediction, or a company’s past performance, regardless of new and potentially more relevant data. This bias can lead to misjudging an investment’s true value.
For example, if you buy a stock at $100 and it drops to $80, you might irrationally hold on to it, hoping it will return to $100, instead of reassessing its current potential based on updated information. This fixation on the original purchase price prevents you from making objective decisions and can result in holding onto poor-performing investments for too long, missing opportunities to cut losses and reinvest in better options. Similarly, if an initial positive news report influenced your decision to buy, you might ignore subsequent negative reports, anchoring your belief in the stock’s value despite evidence to the contrary.
Steps to Avoid Anchoring Bias:
- Conduct thorough research from multiple sources.
- Regularly reassess your investments based on current data, not initial impressions.
- Set clear criteria for buying and selling investments, and stick to them.
Loss Aversion
Loss aversion is the tendency to prefer avoiding losses over acquiring equivalent gains. The pain of losing is psychologically more impactful than the pleasure of gaining, leading investors to make irrational decisions to avoid perceived losses. This bias can lead to overly conservative investment strategies that miss out on growth opportunities, as investors might avoid taking necessary risks that could yield higher returns.
Additionally, loss aversion can cause panic selling during market downturns, locking in losses rather than riding out market volatility. Investors may sell assets at a loss to prevent further declines, only to miss potential rebounds and recovery. This behavior not only solidifies losses but also undermines long-term investment goals and overall portfolio growth.
Steps to Avoid Loss Aversion:
- Focus on long-term goals rather than short-term fluctuations.
- Diversify your portfolio to balance risk and reward.
- Establish rules for rebalancing your portfolio that are based on your overall strategy, not on emotional reactions to market movements.
Herd Behavior
Herd behavior refers to the tendency to mimic the actions of a larger group. In investing, this often manifests as following market trends without conducting individual analysis or due diligence. Following the crowd can lead to buying into bubbles or selling during market panics.
For example, during the dotcom bubble, many investors bought tech stocks at inflated prices because everyone else was doing so, driven by the fear of missing out on potential gains. This collective rush inflated stock prices beyond their fundamental values, creating a bubble. When the bubble eventually burst, those who had followed the herd experienced massive losses. Herd behavior can lead to significant financial consequences, as it often results in decisions based on emotion and social pressure rather than rational, informed analysis.
Steps to Avoid Herd Behavior:
- Be willing to stand apart from the crowd and trust your independent judgment.
- Have a plan and stick to it.
- Read “Wealth on Purpose” by Bryan Ballentine.
Positive Behaviors to Practice Instead
Instead of falling prey to these biases, cultivate behaviors that support sound investment practices:
- Patience: Focus on long-term growth rather than short-term gains. Understand that market fluctuations are normal.
- Discipline: Stick to a well-thought-out investment plan, rebalancing your portfolio as needed but avoiding impulsive decisions.
- Continuous Learning: Stay informed about market trends and continuously educate yourself about investing.
Mastering Your Mindset
Investing successfully requires more than just picking the right stocks or funds; it requires an understanding of your own psychological biases and the discipline to counteract them. By recognizing and avoiding anchoring bias, loss aversion, and herd behavior, and by cultivating patience, discipline, and a commitment to continuous learning, you can significantly improve your investment performance. Remember, the key to successful investing lies in making informed, rational decisions and sticking to your strategy even when emotions run high.
If you have any questions, give us a call, or read Chapter 1 of “Wealth on Purpose” by Bryan Ballentine.
Have a great weekend!
Sources: Located at the bottom of the article.
Golf Tip of the Week
Pros are good at putting because they do these 3 things really well
It’s U.S. Open season, which means the greens are crispy, lightning fast, and in the shape of Pinehurst Golf Club, shaped like turtle shells.
With balls rolling around, over, and through the greens easier than when they settle on the surface, Pinehurst severely tests players’ ability to putt well.
The easiest way to understand how pros navigate around the greens is to divide up the space around the hole into three different circles. I call them scoring zones, and as we explain in the video, here’s what you need to know about each.
Scoring Circle #1: Three-shot zone
The first scoring circle is the distance furthest away from the hole. Generally speaking, it’s anything outside about 50 feet, which usually encompasses chips and pitches. From here, it’s more likely that you’ll finish out in three shots, than in one shot. The goal from here, as Eduardo Molinari explains, is to hit the green and avoid disaster.
Golf Twitter Hall-of-Famer Lou Stagner had a great stats thread recently explaining how, more often than not, that means looking for an excuse to pull a putter.
Scoring Circle #2: The black hole
We call this the black hole because this is where two-putting is the most likely outcome. The exact distance of each of these scoring circles depends on ability level, but for pros, the black hole starts at about nine feet and stretches to about 50 feet.
The goal here is to not be drawn into silly mistakes by trying to make the putt. Going high and soft gives you the best chance of making it—and leaves you in an ideal spot if you don’t.
Scoring Circle #3: ‘I should make this’
Once you get inside about eight feet, you’re in the ‘I should make this’ zone. The key to this zone is making a lot of putts, because that’s how you’ll be able to gain the most on your peers. Obviously that’s easier said than done, so this zone comes down to, above all else, making sure your putterface is square at impact.
Tip adapted from golfdigest.comi
Recipe of the Week
Copycat Texas Roadhouse Rolls
2 Dozen
Ingredients
Dough
- 1 1/2 c. (340 g.) whole milk
- 1/4 c. (50 g.) granulated sugar
- 1 (1/4-oz.) packet or 2 1/4 tsp. active dry yeast
- 3 large eggs, beaten to blend
- 4 Tbsp. (1/2 stick) unsalted butter, softened
- 4 tsp. kosher salt
- 6 3/4 c. (810 g.) all-purpose flour, plus more for dusting
- Neutral oil, for greasing
Cinnamon-Honey Butter
- 1 Tbsp. confectioners’ sugar
- 1 tsp. honey
- 1 tsp. kosher salt
- 3/4 tsp. ground cinnamon
- 3/4 c. (1 1/2 sticks) unsalted butter, softened, divided
- Flaky sea salt (optional)
Instructions
Dough
- In a small saucepan over medium heat, heat milk until warm to the touch, between 100° to 110°. In the large bowl of a stand mixer fitted with the dough hook, combine warm milk, granulated sugar, and yeast. Let sit until yeast is dissolved and foamy, about 10 minutes.
- Add eggs, butter, and kosher salt and beat on low speed until just combined. Add flour and continue to beat on low speed until dough comes together, about 5 minutes.
- Turn out dough onto a lightly floured surface and knead until smooth, about 5 minutes. Transfer dough to a lightly oiled bowl, cover with plastic wrap, and let rise at room temperature until doubled in size, about 1 hour.
- Line 2 baking sheets with parchment. Return dough to lightly floured surface and roll to a 1″-thick rectangle. Using a sharp knife or pizza cutter, cut dough into 2″ squares. Transfer squares to prepared sheets, spacing about 1/2″ apart. Cover each sheet with a dish towel and let rise until doubled in size, about 45 minutes.
Cinnamon-Honey Butter & Assembly
- In a large bowl, whisk confectioners’ sugar, honey, kosher salt, cinnamon, and 1 stick butter until thoroughly combined and fluffy.
- Preheat oven to 375°. Melt remaining 1/2 stick butter in the microwave or in a small pot. Brush each square with butter.
- Bake rolls until golden brown and risen, about 15 minutes.
- Brush rolls with more melted butter and sprinkle with sea salt, if using. Serve with cinnamon-honey butter alongside.
- Make Ahead: Rolls can be made 1 month ahead. Let cool, tightly wrap in foil, then in plastic wrap, and freeze. When ready to eat, let rolls thaw at room temperature overnight. Remove plastic wrap and loosen foil, then bake at 300° for 10 minutes to heat through. Cinnamon-honey butter can be made 7 days ahead. Store in an airtight container and refrigerate. Bring to room temperature before serving.
Recipe adapted from Delish.comii
Travel Tip of the Week
An Iconic Food Festival Is Coming to Charleston — and You Can Get Tickets Now
Get your tastebuds ready, because it’s time to buy tickets to the inaugural Food & Wine Classic in Charleston.
Food & Wine, Southern Living, and Travel + Leisure are coming together for the first-ever iteration of the Classic in the beloved southern city, taking place Sept. 27 to 29. As the trio of publications noted, the weekend will feature more than 40 celebrity chef cooking demonstrations, wine and cocktail seminars with big names like Tyler Florence, Maneet Chauhan, CJ McCollum, Wanda Mann, Amanda McCrossin, and Andrew Zimmern, alongside local talent like Mike Lata, Miles White, Femi Oyediran, Vivian Howard, and, of course, plenty of fun will be had too.
“Charleston’s unparalleled combination of culinary traditions, foodways, hospitality, architectural beauty, and culture makes it the ideal setting to build on our storied Food & Wine Classic event franchise,” Food & Wine’s editor-in-chief Hunter Lewis shared. “Together with my friends at Southern Living and Travel + Leisure, we are excited to showcase the best of the Holy City and create a dynamic experience that tells meaningful stories about the area’s delicious food scene and brings together wine and food lovers from all over for a weekend of celebration, enrichment, and fun.”
Like its sister event, the Food & Wine Classic in Aspen, the Charleston gathering will also feature plenty of tasting opportunities around The Grand Tasting Pavilion for talks on spirits, wine, and all that tasty cuisine. And this time, there will be additional programming to showcase what makes Charleston such a perfect vacation destination, all curated by Travel + Leisure editor-in-chief Jacqui Gifford.
“Year after year, Charleston has been voted the World’s Best City in the U.S. by Travel + Leisure readers, and it’s easy to see why,” Gifford said. “From the cultural attractions and boutique shopping to the ever-evolving restaurant scene and unrivaled Southern hospitality, Charleston is truly one of a kind, and we are thrilled that we can bring this dynamism to life over a magical long weekend of events.”
Not to be outdone, Southern Living will host the Southern Living Lowcountry Tailgate, where attendees can dig into a traditional oyster roast hosted by Matt and Ted Lee, BBQ by Erica Blaire, and live music for good measure.
“We’re excited to celebrate the rich culture of Charleston and to highlight the people who bring it to life,” Sid Evans, editor-in-chief of Southern Living, added. “We’re also thrilled to welcome attendees to our newest Idea House in Kiawah River, which opens in August 2024, as a venue for celebrating the food, traditions, and hospitality of the Lowcountry.”
Tickets for the event are now on sale. You can purchase yours and see all the festival programming at foodandwineclassicincharleston.com.
Tip adapted from travelandleisure.comiii
Copyright (C) 2021. Ballentine Capital Advisors. All rights reserved.
Our mailing address is:
Ballentine Capital Advisors
15 Halton Green Way
Greenville, SC 29607
Sources:
Understanding Investor Behavior
3 Biases That Can Sabotage Your Wealth
What is Anchoring in Investing?
Herd Instinct: Definition, Stock Market Examples, & How to Avoid
Disclosure:
Ballentine Capital Advisors is a registered investment adviser. The advisory services of Ballentine Capital Advisors are not made available in any jurisdiction in which Ballentine Capital Advisors is not registered or is otherwise exempt from registration.
Please review Ballentine Capital Advisors Disclosure Brochure for a complete explanation of fees. Investing involves risks. Investments are not guaranteed and may lose value.
This material is prepared by Ballentine Capital Advisors for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation or any particular security, strategy, or investment product.
No representation is being made that any account will or is likely to achieve future profits or losses similar to those shown. You should not assume that investment decisions we make in the future will be profitable or equal the investment performance of the past. Past performance does not indicate future results.
Advisory services through Ballentine Capital Advisors, Inc.
i https://www.golfdigest.com/story/tour-players-putting-game-plan-stats-strategy-golf-digest-video
ii https://www.delish.com/cooking/recipe-ideas/a41901752/copycat-texas-roadhouse-rolls-recipe/
iii https://www.travelandleisure.com/food-and-wine-classic-charleston-ticket-sale-now-8641303
