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Investing has been a dangerous and haphazard business over the past few years. Markets have moved up and then suddenly plunged creating major issues people who have invested a significant proportion of their savings into the market and retirement plans. As the markets indicate many of mistakes were associated with incorrect thinking about the market. Over the past few years we have seen investors act in an irrational manner which included selling at a loss, high trading volume and even pulling money out of the market. Many of the problems started a decade earlier in the 90’s when nearly all portfolios had some level of return. The wealthy Baby Boomers lost their nerve just a few years from retirement and bounced their investments around in order to maintain their wealth. The average rate of return was around 12.5% for large capitalization stocks from a period of 1970 to 2006. This created a false sense of security and growth. In 2008 the S&P 500 returned a nearly -24% wiping a number of years of growth. Even though most investors made money of their lifetimes fear caused them to quick and rash decisions that resulted in loss. A number of biases have arisen due to the large market fluctuation which have cost lost investment capital (Ferguson, 2008): Availability Bias: Base decisions on what memories or facts we can easily remember. Hindsight Bias: We believed we understood what was happening because we are aware of the facts afterward. Induction: Formulating general rules on insufficient information. Fallacy of Conjunction: We overestimate the probabilities of events happening. Confirmation Bias: Looking only for confirming information and rejecting non-confirming information. Contamination Effects: Allowing irrelevant information impact decisions. Affect Heuristic: Value and judgment interfere with understand of costs and benefits. Scope Neglect: Keeping risks and benefits in proportion. Overconfidence in Calibration: We believe the best case is the most likely. Bystander Apathy: We don’t feel responsible for individual actions when in a crowd. Understanding how bias can impact our thinking we can further understand how to approach our investing. Bias, over optimism, selective factors, and group think has caused major market crashes. The investment market is more about human belief than it is about growth. It grows because people believe it will grow and will put additional money into the market for long term savings. Ferguson, N. (2008). The Ascent of Money: A Financial History of the World. Penguin Books, NewYork, USA. Murad Abel is a multi-published author, business professor, training & development manager, hr manager and runs a consulting agency at http://www.magconsulting.biz as well as other written articles at http://www.magdailyblog.blogspot.com
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