We talk a lot about investor behavior at Azzad. Unlike the ups and downs of markets, it’s one of the few variables investors can control.
We’ve identified three common mistakes we’ve seen over the years. We hope you can use them to improve how you approach the markets.
Mistake 1: Selective Memory
Few of us want to remember a painful event or experience in the past. In terms of investments, we certainly don’t want to remember stock calls that we missed, and especially not ones that proved to be mistakes that ended in losses. The more confident we are, the more such memories threaten our self-image of successful investors. Instead of remembering the past accurately, we tend to remember it selectively so that it suits our needs and preserves our self-image.
Over time, our memory of the event will adjust to fit the image we have of ourselves, but it may not necessarily be accurate. This can lead us to overestimate our investment skills and perhaps take unnecessary risks against the advice of investment professionals.
Mistake 2: Loss Aversion
Many investors will focus obsessively on one investment that’s losing money even if the rest of their portfolio is doing great. This is called loss aversion. Investors are more likely to sell winners in an effort to take profits but are unwilling to accept defeat in the case of the losers. More money has probably been lost by investors holding a stock they no longer wanted until they could “at least come out even” than for any other single reason.
It also doesn’t help that we tend to feel the pain of a loss more strongly than we do the pleasure of a gain. Our unwillingness to accept that pain is one reason we tend to hold on to losers for too long.
Mistake 3: Following the herd
There are thousands of mutual funds, separately managed accounts, and other investments out there. Investors can’t really know very many of them. But people are bombarded with investment ideas from television, social media, websites, and other places. Inevitably, some decide that the latest idea they’ve heard is a better idea than an investment they already own, and they make a trade.
We can all be much better investors when we learn to select stocks carefully and for the right reasons, often in consultation with our Azzad advisor, and then actively block out the noise. Any temporary comfort derived from investing with the crowd or following a market “expert” can lead to fading performance or inappropriate investments for your goals.