Simon Snelder

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Are investors rational or irrational?

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Are the investors rational or irrational?

The psychology of an investor is as important as the investment itself. What makes people decide to invest in something? Is it a rational decision based on different metrics that point towards the right investment or is it something they read or hear about in the media or from friends?

Once the decision is made, what happens to somebody after they invest and how is their experience? One can argue that this is simply based on the performance. However, if the result is a 100% growth in 15 years, what is the investor’s perception of success or failure during and after the term?

Research shows that we are neither rational or irrational. (https://www.researchgate.net/publication/281611609_Are_investors_rational_irrational_or_normal) Investors try to be rational and scientific with their decision based on what to invest and how to manage it, but irrational emotions are not excluded. They can show up at any stage in the investment cycle – at the start by picking the investment because it “feels good”; making a decision to change the strategy during the investment or because greed or fear takes over or at the end. Fear makes you sell your investment when you should stay put and greed makes you hold your investment when you should cash out.

An article on Seeking Alpha describes different types of investment bias that investors can have and most importantly, tend to repeat.

Overconfidence.

Having confidence in life is good, but that does not mean you have full knowledge and experience in investing. People that are overconfident can make errors in going a step too far in to the investment without realizing they are overexposed. This can lead to large losses.

Self-attribution.

In investing this means that when things go right (you make money) they say its due to themselves, but when things go wrong its because of external factors. This stops the investor from being realistic and objective.

Selective memory

It makes investors remember the good decisions, but they “selectively” forget about the bad ones. This stops the investor’s learning curve, because mistakes are made to not be repeated and to learn from.

Self-handicapping

When an investment goes wrong an investor is blaming themselves unnecessary. This lowers their confidence. Sometimes things happen that are out of your control, it doesn’t mean that you have not selected the right asset to invest in.

Herding

Following the crowd. If the crowd decides to invest in something even if its certain to fail, the investor will follow the crowd, because of fear of missing out (FOMO).

Having an investment bias does not mean that you are not going to make money as an investor. It means that you should be aware of this because it might influence your investment decisions and lead to lower returns.

In 2018 the regional chief economist from Saxo Bank gave me great advice in a conversation we had together. He told me to make an investment diary and to register all the investments I make in it. I now record all the investments I made, why I made them, the returns, and the reason why I invested in it in the first place.

I think it is important to be aware of your own investment bias that can hinder you from making money as an investor. Maintaining an investment diary can help you to not make the same mistake again and to have an overview from the successes and failures you had and to see a pattern, which will help you to make better decisions in the future.

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Investment

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