What is Behavioral Investing?

Behavioral Investing is understanding that you and other investors DO NOT make rational decision.  People invest for many other reasons than just to make more money.  For example, do you know someone

• Who would not invest in tobacco or gun manufacturers because they make products that may kill people, even though these companies earn above average returns?
• Who likes to go to Vegas to gamble but thinks investing in the stock market is too risky?
• Who believes that if they previously loss money on one company stock, that company stock is forever a bad stock?

Most of modern finance is based on two assumptions:

1. Faced with a decision, people will choose the rational decision to maximize wealth and reduce labor
2. When predicting the future, personal biases do not affect a future decision

Market data and behavioral finance research indicates that these two assumptions are wrong.  First, maximizing wealth is sometimes not the main priority for investors.  Some investors invest in high flying stocks so they have something to talk about around the water cooler.  Second, personal biases definitely affects a future decision.  If you were burned by a stock in the past, you are more likely not to buy that stock again.

Tip of the Week

Don't panic due to the herd mentality of the market

Many irrational investors will sell now because their stock prices are going down, but if the underlying company and prospects has not changed since you purchased the stock, why sell now and take a loss?

Before selling your stock, you need to know where you are going to put the cash.  You need to find another financial vehicle that will gain a better return than the return on the stock you want to sell.  If you cannot find a better return, then why are you selling?

Irrational Mistake

Herding - Moving with the "market herd" because it is easier than doing a formal analysis of your holdings.  If everyone is doing it, it must be right...right?

Why do people follow the herd? 

1.  Misery loves company - If I sell and lose money when everyone else is losing money, so it does not feel so bad.

2.  If I make a mistake in selling, I can blame it on the market and not myself.  No feeling of regret.