- Investor overconfidence can lead to excessive or active trading, which can cause underperformance. In a 1999 study, the least active traders had annual portfolio return of 18.5%, versus the 11.4% return that the most active traders experienced.
- Fear of loss. When asked to choose between receiving $900 or taking a 90% chance of winning $1000, most people avoid the risk and take the $900. This is despite the fact that the expected outcome is the same in both cases. However, if choosing between losing $900 and take a 90% chance of losing $1000, most people would prefer the second option (with the 90% chance of losing $1000).
- The “disposition effect” is the tendency of investors to sell winning positions and hold onto losing positions. This effect directly contradicts the famous investing rule, “Cut your losses short and let your winners run.”
Misuse of Information
- Gambler’s Fallacy. When asked to choose which is more likely to occur when a coin is tossed—HHHTTT or HTHTTH—most people erroneously believe that the second sequence is more likely. The human mind seeks patterns and is quick to perceive causality in events.
- Attention Bias. A 2006 study posits that individual investors are more likely to buy rather than sell those stocks that catch their attention. For example, when Maria Bartiromo mentions a stock during the Midday Call on CNBC, volume in the stock increases nearly fivefold minutes after the mention.
Cultural Differences in Investing
- International differences in loss aversion. After controlling for factors such as national wealth and growth, a study found that Anglo-Saxon countries are the most tolerant of loss, while investors in eastern Europe have the greatest loss aversion.
- International differences in investor patience. The same study found that investors from Germanic/Nordic countries (85%), Anglo/American countries, Asia (66-68%), and Middle East cultures are more willing to wait.
“The investor’s chief problem—and even his worst enemy—is likely to be himself.”
– Benjamin Graham