Financial Psychology

Most investors don’t act rationally

What does psychology have to do with investments?

If we examine our day-to-day activities we find countless examples of non-rational actions. Likewise it has been shown that most investors don’t act in a much more rational way when it comes to taking decisions about anything concerning their investments. Let’s go over the list:

-Sell while losing and leaving the money in liquid cash so that we miss out on the recovery.

– Buying and selling excessively or without planning.

– Getting carried away by prattlers who swear being able to foresee the future.

-Investing in investment funds that systematically pay less than its reference index and supporting high fixed commissions.

– Buying expensive (when there’s stock market euphoria) and selling cheap (after a correction or in the middle of a crisis).

There are many games and tests that prove our lack of rationality:

One dollar auction, where our winning nature betrays us and makes us pay more than one dollar for the bill.

Or the wine bottle auction, where the participants that have higher last numbers in their identification number bid more money for the wine. (Unconsciously they are conditioned by this number when they write it down in the auction sheet where the bids are listed).

Or the tulip bulb bubble. One bulb of a tulip reached the same price as a house.

If you want to know more about this subject watch this video.

Inbestme’s SCOPE:

Some of our recipes to overcome our tendency to financial irrationality:

– It is essential to know our tolerance to risk.

-Know the market´s volatility: The market has gone down 11 times more than 20%, with an average decrease of 35%. Recently, (2008 to 2009) investors had to stand a maximum fall of up to 56%. All of this without counting many less than 10% falls which are not even considered (a fall of less than a 10% doesn’t even reach the range of correction). Anticipating which will be our reaction to a fall and preparing us for it is an essential exercise.

-To face these possible circumstances, our approach is to create a good plan that suits our necessities. The plan must be accepted and interiorized when you are calm and your mind is clear, never in stressful moments. This plan should be revised periodically, to ensure its validity, so that it stays in the deepest part of our psyche.

If we are able to maintain this promise with ourselves, we will have a greater chance of overcoming the vicissitudes that markets may give us and we will be consistent with our plan. It’s important to know that the markets reward discipline!

Index funds, etfs and pension plans

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