Sometimes our emotional and cognitive tendencies can disrupt our ability to make informed, appropriate decisions, especially when investment and finances are concerned. Decisions based on habit, emotion, or speculations often have undesirable outcomes, either immediately or down the line. When these decisions involve investments, the implications can be significant. That’s why relying on scientific mathematical data is critical to creating an optimal stock portfolio. We have to ignore gut feelings and temptations like “it’s such a bargain!” and “everyone is buying that!” Like mom always said, “what if everyone jumped off a bridge?” And so, let’s review some of the most common pitfalls to successful investing:
Herd Mentality
This happens when we listen to “experts” and “thought leaders” who interpret the news and economic events with their own biases and emotions. Naturally, our individual thoughts and opinions are often influenced by the society around us, especially by those considered to be “in the know”. But is that always the way to get the best information? Probably not. Facebook’s Initial Public Offering is a great example. At the time, most experts said that Facebook stock was going to be a great investment and share prices would soar. But in practice, prices stayed low after the launch, disappointing investors.
Conformity
Lining up with the crowd. As humans, we have a tendency to go with the flow and conform to society, even when it isn’t the most logical choice. In finance and investing, this tendency is often related to fear or social pressure. But this fear of being different can lead to major financial losses. As in the Facebook case above, many investors choose to invest in stocks that seem popular, instead of trying something different – but perhaps less known – that may lead to pleasant surprises.
Anchoring
The tendency to believe that a specific situation is good or bad for investing based on something arbitrary, such as a particular price, risk level, or any other detail that happened to be the first thing we heard. For example, we may instinctively comply when someone says “buy that stock now before it goes down”, even though that’s unfounded and illogical advice. There is no objective reason to buy now but you may still do just that simply because someone suggested it. Humans naturally like simple, easy decisions and so anchoring those decisions on advice can feel right, whether or not it’s good advice.
Confirmation Bias
The search for information that corroborates our beliefs. This is such a strong bias that it makes it easy to predict human behavior. This means that if we believe a certain investment is sound, we are likely to find reasons to continue believing in it even after it starts showing negative results. In other words, once we reach a conclusion we often search for information to back our decision, among other investors, investment managers, past stock statistics, and more.
Exaggerated Focus on Losses
The tendency to pay more attention to losses than to gains. When we do this, we are often willing to go to any lengths to avoid these losses, especially when we’re experiencing personal difficulties or larger-scale financial turbulence. When we try to avoid loss due to fear, we often make unsound financial decisions. Studies have shown that most people prefer to avoid loss than to actively gain. They are even more likely to take risks to avoid loss than to take risks that could lead to profits, a decision that is purely emotional, not rational.
Mental Accounting
The tendency to mentally split our money into two or more virtual categories and use one for investments that we consider low-risk and another for investments that we consider high-risk. In reality, every dollar is the same and all of a person’s investments are part of one larger investment strategy that should include some high-risk as well as some low-risk investments.
Human nature provides plenty of cognitive and emotional obstacles to wise investing. Therefore, there is a real need for a scientific-mathematical platform that can overcome emotion, human nature, and the need for external validation. The solution is software that can provide empirical information and neutralize all the emotional obstacles to good decision-making.
This is what Cherries is all about. The revolutionary online stock portfolio builder creates mathematically-optimized portfolios. Users can choose their favorite sectors and preferred risk levels and Cherries will then builds stock portfolios with the best possible risk-reward ratio. The platform performs comprehensive analysis on millions of pieces of data to ensure that its conclusions are based entirely on logic and hard facts. Emotion is eliminated as a factor from the very beginning so you can be sure that the portfolio Cherries has created for you is objective, rational, and not driven by gut feelings. Instincts and emotions are important factors in many aspects of life but work against us when it comes to investing.