The three biggest destroyers of private investor wealth are:

• buying high, selling low
• trading too often
• Not being sufficiently diversified

But why do investors do it to themselves?  There are many well-documented psychological biases which can adversely affect the financial decision-making of private investors. If you know what they are, you are probably less likely to be adversely affected by them. Here’s a list of five of my favourites:

1. Mental Accounting
   If you are gambling at a race track or casino and you have been fortunate enough to win; you might tend to be more risk-seeking with your earnings than you would be with your principal. This is en example of mental accounting.
   This is irrational investor behaviour because a £1 of “house money” has an identical value to £1 of “stake” money i.e. £1.
2. Loss Aversion
   For investors who experience a loss there is a tendency for them to feel disproportionately more pain by losing money than they would feel satisfaction in gaining an equal amount of money.
3. Myopic Loss Aversion
   This is the tendency to focus on avoiding short-term losses, even at the expense of long- term gains. At Proposito one of our most important roles is to ensure that our clients do not fall victim to their own emotions.
4. Endowment Effect
   It is not unusual to consider something you own to be worth more than it would be if you didn’t own it.  This is the endowment effect.  A common occurrence of this effect can be seen when home owners compare the value of their house with the value of a similar property.
5. Information Cascades
   Many investors ignore objective information and instead focus on emulating the actions of others. These are information cascades.  For example, some investors have a tendency to sell a stock solely because the price is falling (others are bidding the price down), or buy a stock as its price rises (solely because others are bidding the price up). This is also known as “herding”.  This was seen with dramatic consequences in the late 90’s as private investors piled into technology stocks only to sell as the value of their investments plummeted.

 At Proposito Financial Planning we try to protect our clients from themselves.  Bad investment choices occur when investors let their emotions get in the way of rational investment decisions. Emotion has no place in investing.  To find out how you can benefit from the investing discipline that Proposito Financial Planning can provide please give us a call on 0845 345 3536 or email us on info@proposito.co.uk