Does Investor Bias Make You Underperform the Market?
By Douglas Goldstein CFP® - helping olim handle their U.S. investments from Israel
A friend recently had a losing streak at the casino. Instead of walking away, he played more hands of blackjack. “I was determined to win,” he lamented. In fact, he was playing to recoup his losses.
He was a victim of investment biases subconsciously affecting his decision-making. Gambler’s Fallacy – the belief that after a streak of losses his luck would turn – duped him into doubling his losses. A recent study of Major League Baseball umpires showed how biases are at work in all forms of decision-making. In 1.5 million pitches, umpires were less likely to call a strike if the previous pitch was a strike.
Investor bias can lead you to make bad investing decisions. Biases are shortcuts in decision-making; you may, for example, increase your position in gold stocks because you have recently made a lot of money in gold, ignoring economic news that suggests gold prices are likely to drop. If you make a bet based on what just happened, you suffer from “Recency Bias,” like the umpire, who is more likely to call a ball after two strikes than one.
Passive and automated investment systems (such as dollar cost averaging) outperform active traders because they eliminate such human biases and judgements. Dollar cost averaging – making fixed investments on a regular schedule – improves returns by reducing volatility and human error.
Why do investors actively trade stocks?
The answer is overconfidence bias. Overconfident investors believe they have an edge over others; they are better stock pickers and market timers. The more humbling reality is that overconfident investors underperform the market. They are more likely to act on gut instinct than on research and analysis.
The major obstacle between you and better investment returns is often yourself. By making rational decisions and not letting your emotions dictate your trade orders, you may improve your investment results. To learn more about investor bias, read my blog, ProfilePerspectives.com/investor-bias
Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation about handling your U.S. investments from Israel. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
