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I have explained in previous articles about how you should try to avoid behavourial biases when it comes to investing in the share market. It is hard; after all by definition it is in our nature. Every now and again however I think we need a wake up call to make sure you are not making the same mistakes over and over again. More importantly perhaps, to make sure you are not using some of the familiar common excuses I hear regularly to justify making those wrong decisions.
There are two behavourial biases I want to focus in on in this article. The first is how human beings will instinctively assume something was obvious after the event in question when they have the power of hindsight. The second is that investors will commonly try to seek information to back up their beliefs but ignore information that undermines it. Furthermore to this they will often rely on generalisations to justify these actions.
Here are some of the comments I hear from Hudson members on a regular basis when discussing their direct share investments:
- I made a bad investment but I will wait for it to return. This is not always a bad decision, but do it for the right reason. Do it because you genuinely believe the stock will return and not because your ego has taken a hit and you need the share price to return to make you feel better about yourself. If you think there may be better investment opportunities out there, sell up, carry forward the loss and move on.
- I only invest in blue chips because they’re safe. There is no one company that is a safe bet. Just look to Australia’s largest company BHP for proof of that. If you invested in BHP just over a year ago you would have paid anywhere up to $39 a share. The price currently resides around $37, while the market as a whole has lifted over 5% over the same time. There is also no guarantee a diversified holding in blue chips only will perform as well as investing in the entire market.
- I’m waiting for more certainty in the markets. Boy have I heard this one a few times. This essentially comes down to whether you are a long-term investor. If you are looking to invest for a year, or two years, then by all means try to time the market in this fashion. In the long term however what is rewarded is discipline and patience. If you have a 5 year outlook tell me which is the wiser investment decision …
Invest in a diversified share portfolio or managed fund and receive around 4% in dividends/distributions per annum, with a good chance of 20% capital growth in five years time.
Invest in term deposits and receive around 4% in interest per annum, but with no capital growth potential.
- I know or work for the company or in the industry. I’ve covered this one before but I still hear this comment from time to time. Remember that 99% of the knowledge you have about a company or industry is in the public domain and likely factored in to the share price.
- Surely we could have seen the market crash coming prior to the GFC? Short answer … NO, we could not. It is easy to say this now, but in November 2007 there was no guaranteed way to know the markets were about to head south. If there was, it would have happened overnight, not over 16 months.
Ironically the biggest move out of growth assets in to defensive assets occurred in March 2009. i.e. investors effectively predicted the bottom of the market, but at their own expense, jumping OUT of the market just as it was about to head onwards and upwards.