Traps to avoid with our investments

 

Traditional finance takes for granted that each and every one of us adopt a rational financial behavior. Basically, what it means, is that everyone have access to the same information, at the same time and act at the best of their own interest.

 

 

The research concerning behavioral finance are constantly expanding and allow us today, to discover new knowledge concerning the real behavior of the financial markets. I summarized below the six most common harmful behaviors we can observe in financial markets:

 

 

1 – Anchorage: "The strong inclination of an investor to cling to a belief, data or past experience".

 

Example : An investor is reluctant to buy additional securities from an investment because it was cheaper last year.

Impact : Relying on meaningless numbers or past returns can be dangerous or make us miss opportunities. Almost all titles are more expensive today than they were at the end of 2008!

 

 

2 – Frame: "The views and decisions of investors depend largely on how the situation or choices are presented".

 

Example: A client who prefers to invest in his country or in his employers stock.

Impact: If the investor does not step back and see beyond the frame (so that a tree does not hide the forest), he may miss opportunities. It may also take on too much risk by not having geographical, sectoral or assets diversification.

 

 

3 – Aversion to loss: "Feel greater anxiety about loss than pleasure experienced after a gain, no matter the investment scale".

 

Example: An investor who tends to retain his securities long after a loss hopes to regain what he has lost.

Impact: The investor may ignore the fundamental characteristics of the company and retain a title irrationally hoping to avoid the pain that accompanies the realization of a loss. Several will be able to relate here with Nortel.

 

4 - Excessive confidence: "When the investor overestimates his ability to choose a good investment or make a good decision".

 

Example: An investor is convinced that a particular investment will make him win big.

Impact: Risk of venturing beyond the circle of his competence. Also, the investor who is "certain" to make a good move, may not pay enough attention to the risks of the investment in question.

 

5 - Aversion to ambiguity: "Preferring to take known risks than unknown risks".

Example: An investor who converts his securities into cash and who expects markets to rebound before investing.

Impact: Risk of missing opportunities as we wait for familiar events to occur.

 

 

6 - Tendency to avoid regret: "Avoid potential regrets for making bad decisions (choose a losing investment or not choose a winning investment)".

 

Example: An investor who does not act, for fear of making a mistake.

Impact: Here the investor does not make a bad investment by not moving but it does not make a good investment either.

 

 

I have written this comment to give you my opinion on various investment solutions and considerations that may be relevant to your investment portfolio. This comment reflects only my views and may not reflect those of National Bank Financial Group. In expressing these views, I try to apply my best judgment and professional experience from the point of view of a person who is required to follow a wide range of investments. Therefore, this report represents my informed opinion and not a research analysis produced by the National Bank Financial Research Department.

 

I hope you enjoyed my article. Do not hesitate to contact me if you have any questions.