In case our first and second parts of this series did not convince you, here is an article from Forbes Magazine, highlighting the mistakes most investors (yes, that means you and I) make when investing. The points it makes echo many concepts that come from Behavioral Economics:
Overconfidence. The overconfidence bias states that most people consider themselves better than average. Ask any group of people what their driving abilities are like and, on average, they will reply that their abilities are above average. Same applies to investing abilities. On the other hand, why would you compete with all the investors out there if you didn’t think you were above average?
Going with the Crowd. This, in behavioral economics, is known as Groupthink. In other words, you are much more likely to invest in stocks that other people have been talking about and investing in than equally good stocks that haven’t been mentioned as much.
Stubbornness. Two things are at work here: First of all, the unwillingness to admit defeat. Even if your stock is down 50%, if you haven’t sold it then you haven’t given up, so you might as well continue. Secondly, people grow attached to a stock. As Ariely points out in his book Predictably Irrational, people overvalue what they have. Stocks are no exception.
The only bone of contention we have with this article is its final paragraph, which states:
But keep in mind the possibility that you are fooling yourself and would do better buying index funds
We’d recommend not to rely on index funds either, since their performance still depends very much on time frame.
