Your Subconscious in the Market: A Deep Dive into the Role of Emotions

Investments are not just a number on paper; they are a complex dance between your subconscious, your emotions, and market risks. Research has revealed that we humans are not immune to the dramatic swings in the market, and our reactions are influenced by a multitude of factors. Headlines can create anxiety, misinformation can lead to incorrect decisions, and the influence of individuals in our environment can shape our investment strategies.

According to studies, we are particularly vulnerable when the market declines. The fear of losing money triggers impulsive selling decisions, which can be detrimental to long-term returns. On the other hand, when the market rises, the allure of greed can lead us to take greater risks and invest more than we should. In these critical moments, it is crucial to stick to the original plan and avoid letting emotions dictate our decisions.

A notable observation is the significant gap between market returns and investors' actual returns. This discrepancy arises when emotions take precedence, leading us to buy and sell at the wrong times. Historically, those who have adhered to a carefully crafted plan have outperformed those who let emotions dictate their actions. It is a clear indication that a well-thought-out strategy and discipline are crucial for achieving long-term successful investments.

To ensure sustainable and long-term returns, it is therefore of the utmost importance for investors to actively manage their emotions and not be swayed by the short-term fluctuations in the market. By understanding the complex relationship between one's subconscious, emotions, and investment decisions, a strong foundation for success in the dynamic world of economics and finance can be established.

Human Bias in Investments: Five Pitfalls to Avoid

Many of us imagine that our investment decisions are rational and well-founded, but reality is complex. Our cognitive thinking and subconscious have a significantly greater impact than we might realize. Here, we highlight five key cognitive biases that affect us both as investors and individuals:

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1. Context Bias: How information is presented to us influences our decisions, especially in investments. Positively framed alternatives can attract us, even if they may not be the best financial decisions. On the other hand, a negative presentation of a financial risk can make us reluctant, even if there is the potential for higher returns.

2. Default Bias: Default bias occurs when we favor what is pre-set or presented as the default choice, even if it is not the most advantageous option for us. For instance, we may stick to default pension options despite the availability of alternatives with higher returns. Similarly, default loan payment plans may attract us, even though they may involve higher fees or interest rates.

3. Information Availability Bias: This bias arises when we make decisions based on readily available information instead of carefully considering all the data at hand. Investing in a company that is highly talked about in the media is an example of this bias, where easily accessible information may overshadow other relevant factors that should be taken into account

4. Overconfidence: Overconfidence occurs when we overestimate our ability to predict future outcomes or control a situation. Being excessively confident in our investment decisions can lead us to take on excessive risks or ignore warning signs. Overoptimism about future earnings can also lead us to spend too much and save too little.

5. Mental Accounting: We treat and categorize money in various ways based on subjective criteria, known as mental accounting. This can lead to irrational decisions, such as spending a bonus on leisure activities instead of paying off debts. The choice to save money in a low-interest account instead of investing, based on how we mentally categorize the money, is also an example of this bias

By being aware of these biases and actively working to avoid them, investors can enhance their ability to make long-term wise and well-informed decisions, whether they impact financial investments or personal finances.

To time the market, or not

Attempting to time the market, i.e., buying and selling assets based on predictions of its future movements, is a tempting strategy that many investors try to employ. However, there are several reasons why this can be a risky strategy. Here are four key tips highlighting why it might be wise to avoid trying to time the market:

1. The normal state is an upward trend, not a downturn: Since 1950, the U.S. stock market has generally risen about three out of four calendar years. This indicates that the normal state is an upward trend rather than a downturn. Focusing on five-year average return figures, advocated by investment guru Warren Buffett, can help avoid concerns about short-term fluctuations.

2. Markets and the economy don't always correlate: Performance in financial markets can significantly differ from economic developments. Financial markets are often forward-looking and can react to expectations, while macroeconomic indicators are backward-looking and reflect historical data. This can lead to the market moving before the economy shows clear signs of improvement or deterioration.

3. Easy to sell, hard to buy: Many investors find it tempting to sell when they believe markets are poised to decline. This leaves long-term investors with two options. Either they attempt to buy back in when markets look better, which can be challenging to time correctly. The second option is to stick to the original plan, avoid hasty decisions, and not miss out on the best days or months following a positive turnaround.

4. Be prepared and avoid excessive risk: Instead of trying to time the market, it is wise to be prepared for fluctuations. Have an investment portfolio tailored to your circumstances and risk tolerance. A diversified portfolio can help minimize losses and facilitate quicker recovery when the market turns. Additionally, it's important to be aware that your perceived risk tolerance may differ from your actual tolerance, especially if you have limited experience with significant market downturns

Finally, in the complex landscape of investments, it's important to remember that every decision is associated with a certain degree of risk. Past performance is no guarantee of future results, and the value of invested capital can both increase and decrease. There is no absolute certainty that the entire invested capital will be returned. The information provided here does not constitute advice, and it is always wise to seek guidance from a qualified advisor who can tailor the investment strategy to your specific financial situation.

So, before diving into the world of investments, be aware of the risks involved and seek professional advice to create a strategy tailored to your individual goals and risk tolerance. Being informed and aware will strengthen your ability to navigate through complex decision-making processes and increase the likelihood of making well-informed and sustainable investments. Best of luck on your investment journey!

Source: Formue