There are some basic investing mistakes that all beginners make when first getting in to the market. I’ve seen these investing mistakes over and over again, and I’ve made the same ones myself.
So you want to be aware of these mistakes and avoid them as much as possible. The interesting part of this investing mistakes post is that it deals with mindset issues.
Especially when you are investing money, your attitudes and emotions need to be kept in check. You could be a know-it-all in the stock market, but this alone won’t make you wealthy.
You need to be able to control the person you see in the mirror. If you can control your emotions, if you can control your thinking, then you are on your way to success in the stock market. This comes through understanding the inherent, natural biases that all humans possess. Once you are aware of these biases, you’ll be able to prevent them from ruining your portfolio.
Bias #1- Hindsight Bias
They say that everything looks clear in hindsight, and this couldn’t be more true in investing. Beginners especially fall into the hindsight bias trap. Hindsight bias means taking events that already have happened and believing that you knew it was going to happen all along.
For example, the banking fail crash of 2008 and 2009 caught all of Wall Street by surprise. Very few people were able to predict the crash, if any, and many investors lost their shirts. If everyone knew that the crash was going to happen, the stock market wouldn’t have been at such highs before the crash. Everyone would’ve sold their stocks before the crash, and obviously that didn’t happen.
Investors today, however, may believe that they would’ve been able to realize a crash was happening and get out in time. Or, they may now believe that they wouldn’t have owned a stock like Washington Mutual or Lehman Brothers, because obviously they were risky stocks.
But that’s where this fallacy kicks in! Not many understood at the time that these stocks were about to go bankrupt! So many investors got hurt in these stocks, and so it’s clear that they were caught by surprise.
Hindsight bias makes investors think they would’ve been smart enough to avoid those two stocks. The overconfidence present in every human being and our general optimism makes us believe it can’t happen to us. This blind bias is dangerous, and is an extremely common investing mistake.
You have to be careful of stock researchers who use hindsight bias to try and sell you their product. They may look at a stock like Google (GOOG) and say that they would’ve been able to pick out that stock in the beginning. Or they may look at indicators and claim to have known this stock was a sure buy early on.
Beware of these data manipulators. When they are only telling you one side of the story, they are often employing hindsight bias to trick you to believe them. You need to recognize when this is this case and stiff arm them away from your life.
Instead look for stock researchers who tell you both sides of the story. They may have been able to identify some good winners looking back, but also admit to have picked some losers. These are the guys you want to listen to.
Hindsight bias makes people believe they are able to win all the time, and this is never the case.
Bias #2 – Confirmation Bias
I don’t care who you are, everyone and I mean EVERYONE has deceived themselves with confirmation bias. Confirmation bias means seeking out information that you believe is true and using this evidence to confirm your opinion.
The reality of life is that many opinions have two sides to the story. Oftentimes a good argument can be made for both sides of the story. This is especially true with investing. If you want to believe that a stock is a buy, i can guarantee you that you can Google search at least 10 articles that agree with you. You may then read this article, see that someone agrees with you, and then decide you want to buy that stock.
Don’t do this when you are investing. You can always find an argument to buy or sell a stock at any time, literally all the time.
You need to understand that confirmation bias can make you seek out only what you want to hear. Don’t, don’t, don’t do that. Instead try to take an unbiased opinion at all times when you are making an investment decision. Look at both sides of the argument, and then use logic to make your decision.
Investing mistakes like confirmation bias can burn you. It’s easily avoided, if you take the time.
Bias #3 – Survivorship Bias
This bias goes hand and hand with the hindsight bias, and people often overlook it. Survivorship bias is the result of the way things work. When a company goes bankrupt, they are no longer listed in the stock exchange. As such, the companies you look at today are the only ones that haven’t gone bankrupt yet. In other words these companies have survived.
This can be a problem when you are researching about companies. You may look at a strategy and backtest it 10 years, but only examine companies who have survived. People often do this in their backtests because the surviving companies are the easiest available list to choose from. You can easily get a list of the current S&P 500 companies right now, but try doing that for 1996. The information isn’t as readily available, and it’s harder to obtain.
This becomes a common investing mistake because it’s easy to overlook this survivorship bias when you aren’t aware of it. Smart and experienced stock researchers fall victim to this bias like beginners do. And so some backtest data out there is actually very inaccurate because the tester hasn’t accounted for survivorship bias.
I see this so much in amateur financial articles. The writers who write the article may not be aware of survivorship bias, and may then write an article and show some backtest data that is actually more optimistic than it should be. Since they aren’t taking survivorship bias into consideration, their data can be very wrong and mislead their readers.
The only way to avoid believing inaccurate data like this is to be knowledgable about it. If a person doesn’t explicitly mention how their test combats survivorship bias, you can be almost certain that they didn’t take it into consideration. For that reason, you must take their data with a grain of salt.
Survivorship bias is dangerous because companies that have gone bankrupt aren’t included. This skews data and misleads investors. It can make investing strategies look sound when they really aren’t. Just be careful about it.
I hope this post doesn’t scare you off from wanting to invest. These are all things that you do need to worry about, but you only have to learn it once.
A post like this is like a painful work out. It might discourage you at first but it makes you stronger in the long run.
These investing mistakes are easily avoidable now that you know about them. I hope you’ve gained some skepticism about investing information out there. You should be able to identify less than credible sources now, and stiff arm them.
If you’re eager to take what you’ve learned and now try to pick out some winning stocks, take the Stock Market 101: Wall Street Challenge. Combine the challenge with what you’ve just learned in this post, and you’ll be better equipped than most of the average investors out there.
Learning about investing is hard work. You might not like that there’s no easy shortcut to avoid this. But if you ask any successful entrepreneur, any successful writer or any successful athlete, they’ll tell you the same thing. Success comes from hard work alone.
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**3 Investing Mistakes by Beginners – Wisdom Wednesdays #25**
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