More often than not, an investor’s worst enemy is his own brain. A myriad of behavioral biases to which we, as human beings, are predisposed are constantly threatening to knock investors off the track to success.
In a recent interview with AOL’s Daily Finance, Meir Statman, a pioneer in the field of behavioral finance, outlines several of the most common biases that dog investors.
Among the portfolio-punishing traps: Hindsight Error, which Statman calls “one of the most pernicious mistakes”. The idea is that investors believe their ability to clearly see the past means they have an ability to see the future. Writes Daily Finance’s Charles Wallace: “Hindsight error is common at the moment, Statman says, because many people are convinced they saw the crash coming in 2007. In reality, they may have thought a crash was possible, but they also thought the market might continue to zoom upward.” Now, their erroneous recollection has them thinking that they’ll be able to time the market’s highs and lows in the future, which is nearly impossible to do.
Another of the biases to which many investors fall prey, according to Statman: confirmation errors. This is the predisposition to look for information that supports your own hypothesis, and ignore information that contradicts it.
Statman also discusses a number of other common biases, including the “illusion of control”, “affinity of groups”, and “extrapolation errors”. To read the full list, click the link above.