Investing is often an emotional experience for many due to the uncertainties that accompany the deployment of capital across various securities. To succeed, investors need to understand the biases and mistakes they might make during their investment journey. Here are four common but subtle mistakes to watch out for:
1. Sunk Cost Fallacy
The sunk cost fallacy occurs when investors remain attached to a losing investment solely because of how much they’ve already committed—whether in terms of time, effort, or money. While this is a natural reaction in many situations, it can be detrimental in investing. Instead of evaluating the current state of an asset or security, investors base their decisions on their past investments.
Tip: Focus on the current fundamentals and prospects of your investment rather than its history. Letting go of underperforming investments can free up capital for better opportunities.
2. Outcome Dependency
Outcome dependency is like the sunk cost fallacy but involves being overly attached to the expected outcome of an investment. This is common in speculative trades where investors hold on to a losing position, hoping for a turnaround.
While patience can sometimes pay off—particularly with certain asset classes—this strategy is high-risk and may not suit risk-averse investors.
Tip: Diversify your investments and regularly reassess your portfolio to ensure it aligns with your risk tolerance and long-term goals.
3. High Investment Turnover
Frequently buying and selling investments is a sure way to erode returns. High turnover not only increases transaction costs but also limits the potential for compounding.
Understanding the fundamentals of your investments helps build the confidence to hold your positions, even during periods of volatility. Impatiently taking profits too early can stifle your long-term growth potential.
Tip: Commit to a disciplined investment strategy, focusing on the quality and potential of your assets rather than short-term market movements.
4. Timing the Market
Trying to time the market is akin to jumping on or off a moving train—highly risky and often disastrous. Despite claims from many “get-rich-quick” schemes, predicting market movements with precision is nearly impossible.
A landmark study, Determinants of Portfolio Performance (Financial Analysts Journal, 1986), found that 94% of portfolio returns are driven by asset allocation decisions, not market timing or security selection.
Tip: Focus on building a well-diversified portfolio with a long-term perspective rather than attempting to outsmart the market.