Nothing is as difficult for people as not deceiving themselves. While some self-delusions are relatively costless, those relating to investments can be expensive.
We delude ourselves for a number of reasons, but one of the principal causes is a need to protect our own egos. So we look for external evidence that supports the myths we hold about ourselves, and we dismiss those facts that are incompatible.
Psychologists call this “confirmation bias”—a tendency to select facts that suit our own internal beliefs. A related ingrained tendency, known as “hindsight bias,” involves seeing everything as obvious and predictable after the fact.
These biases are evident among many investors every day and are often encouraged by the media.
Here are common ways investors fool themselves:
“I knew the market was going to crash.” I have had a lot of people tell me that, but not one has shown me how they profited from it, other than saying they went to all cash. Of course, there is no way for me to know when they went to cash, if you catch my drift.
“I only invest in ‘blue-chip’ companies.” People often gravitate to the familiar and to shares they see as solid. But a company’s profile and whether or not it is a good investment are not necessarily correlated. Better to diversify.
“I’m waiting for things to go back to normal.” The emotions triggered by volatility are understandable, but acting on those emotions can be counterproductive. Uncertainty goes with investing. Historically, long-term discipline has been rewarded. When is the stock market ever normal?”
“I know about this industry, so I’m going to buy the stock.” People often assume that success in investment requires a specialist’s knowledge of a sector. But that information is usually already reflected in the price. You aren’t the only one that knows about your industry. Literally millions of people do.
This is by no means an exhaustive list. In fact, the capacity for human beings to delude themselves in the world of investment is never-ending.
But overcoming self-deception is not impossible. It just starts with recognizing that we are not wired for disciplined investing. We will always find one way or another of rationalizing an emotional reaction to market events.
But that’s why even experienced investors engage advisors who know them, and who understand their circumstances, risk appetites, and long-term goals. The role of that advisor is to listen to and acknowledge our very human fears, while keeping us in the plans we committed to at our most lucid and logical.
We will always try to fool ourselves. But to quote a piece of folk wisdom, the essence of self-discipline is to do the important thing rather than the urgent thing.