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Do you know what investing and sport have in common?
Come on, come on…NOOOO!!!
They both rely heavily on psychology.
As the great Warren Buffet said:
‘The most important quality for an investor is temperament, not intellect’.
So how can we work to be the best investing versions of ourselves?
Let’s dive into some behavioural finance.
First off, prepare to lose.
You are going to lose on some of your investments. Shocking, I know.
And psychologically it’s extremely important to learn how to lose.
Because while losses may feel bad sometimes, experienced investors tend to focus on the long term to try and average them out.
For example, the S&P 500 makes an average gain of 11% a year, but it’s important to remember that it’s not going to make a gain every year.
There might be some years where there are losses.
It’s the long term average that keeps investors coming back.
Next up – Be aware of bias.
Bias is a term used in behavioural finance to describe how investors may be swayed and make incorrect investment decisions. Let’s explore three kinds of bias.
Number one – Familiarity bias
This is when investors focus on assets they are familiar with, rather than exploring new areas that might actually see their portfolio perform better.
In other words, the fact that you like McDonald’s doesn’t mean you can’t consider investing in Dominos.
You might think investing in what you are familiar with is easier, but exploring more investment ideas can expose you to more opportunities.
Bias number two – Confirmation bias
This is where we as investors have a bias towards information that confirms our views, even if that information is flawed or incorrect.
Many investors search for articles and other sources that reaffirm their beliefs. BUT in order to make an informed investment decision, it is always important to consider different perspectives.
And bias number 3 – Loss aversion bias.
This bias refers to the tendency of investors’ to lean towards avoiding losses over seeking gains.
For example, an investor may be hesitant to invest their cash for fear of making a loss, but the reality may be there’s an opportunity cost as that uninvested cash is being eroded by inflation.
So how can we overcome it?
Understand your risk profile and make investment decisions accordingly, so you may want to take some risks if the opportunity has a higher potential for gains in the long run.
Another way to reduce the risks is by having a well-diversified portfolio.
So, next time you’re experiencing FOMO, or wondering why on earth you decided to get into an investment, just remember what we’ve learned here today:
Investing is heavily based on psychology. So have a plan. Stick to it. Remember that losses are part of the journey. And try not to be biased when it comes to your investment decisions.
Thank you for watching, and I’ll see you in the next video here at the eToro Academy.