Common investing mistakes and biases
Often the biggest risk to your investment is you. The most frequent mistakes, the biases behind them and how to protect yourself.
Studies of investors find something uncomfortable: on average, people earn less than the very funds they invest in, because they buy after something has risen and sell after it has fallen. It's not a lack of intelligence; it's how our brains work with money.
The most common biases
| Bias | What it is | How it shows up |
|---|---|---|
| Loss aversion | A loss hurts more than an equal gain pleases | Panic selling, or never selling something that fell |
| Herd behavior | Doing what everyone does | Buying what's trendy on social media after it already rose a lot |
| Overconfidence | Believing you know more than the market | Trading too much and concentrating in a few stocks |
| Confirmation bias | Seeking only information that proves you right | Ignoring signs that your idea no longer holds |
| Anchoring | Getting stuck on a number | "I won't sell until it gets back to what I paid" |
| Recency bias | Believing what happened recently will keep happening | Expecting a +40% year to repeat |
The most expensive mistakes
- Investing money you'll need soon: it forces you to sell at the worst time.
- Trying to time the market: missing a handful of the market's best days greatly reduces returns, and those days usually come right after the worst ones.
- Concentrating in one stock or theme: what looks safe today can fall a lot.
- Trading too much: fees, taxes and emotional decisions.
- Ignoring costs: a fund charging 2% a year eats a good part of the return.
- Following "tips" without understanding them: if you don't know why you bought, you won't know when to sell.
- Falling for fraud: guaranteed returns, pressure to decide fast or "bringing in more people".
How to protect yourself from yourself
- Write your plan: goals, target mix and what you'll do if the market drops 20%. Deciding calmly prevents deciding in fear.
- Write why you buy: before buying a stock, note the reason and what would have to happen for it to stop making sense.
- Automate: fixed contributions and rebalancing once a year.
- Look less: checking your portfolio every day raises anxiety and the urge to tinker.
- Diversify: that way no single mistake is catastrophic.
Test what you learned
1. What describes herd behavior?
- Doing what everyone does, like buying what's trendy
- Diversifying across many assets
- Paying lower fees
Show the answer
Doing what everyone does, like buying what's trendy. It often leads to buying after something has already risen a lot.
2. "I won't sell until it gets back to what I paid." Which bias is it?
- Anchoring
- Diversification
- Compound interest
Show the answer
Anchoring. You get stuck on the purchase price, which the market doesn't care about.
3. What helps you not decide in fear when the market falls?
- Checking the portfolio every hour
- Having a written plan decided calmly
- Following social media tips
Show the answer
Having a written plan decided calmly. You decide in advance, calmly, what you'll do in a drop.
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Everything in this section is educational: it explains how investing works, it doesn't tell you what to buy.