The Five Mental Traps Investors Are Falling Into Right Now

The comments below are an edited and abridged synopsis of an article by Lance Roberts

With valuations elevated, prices at record highs, and the current bull market the longest in US history, it seems like a good time to review the most dangerous psychological biases of investing.

The Five Mental Traps Investors Are Falling Into Right Now | BullionBuzz
A businesswoman places her hand on her head as she looks up with a sense of concern and confusion as she is trapped within the confines of a cube that has been drawn around her.

Cognitive biases are a curse to portfolio management as they impair the ability to remain emotionally disconnected from our money. As history shows, investors always do the opposite of what they should when it comes to investing their own money.

Here are the top five of the most insidious biases investors are falling into right now: confirmation bias; gambler’s fallacy; probability neglect; herd bias; and recency bias. Roberts discusses each one in detail.

The market’s ability to seemingly recover from every setback, and to ignore fundamental issues, has led investors to feel bulletproof as investment success breeds overconfidence.

The reality is that rising asset prices, particularly when driven by emotional exuberance, hides investment mistakes in the short term. Poor, or deteriorating, fundamentals, excessive valuations, and/or rising credit risk is often ignored as prices increase. Unfortunately, it is only after the damage is done the realization of those risks occurs.

For investors, it is important to understand that markets run in full cycles (up and down). While the bullish up cycle lasts twice as long as the bearish down cycle, the majority of the previous gains are repeatedly destroyed.

The damage to investors is not a result of lagging markets as they rise, but in capturing the inevitable reversion.

Despite the best of intentions, it is nearly impossible for individuals to be devoid of the emotional biases that inevitably lead to poor decision making over time. This is why all great investors have strict investment disciplines they follow to reduce the effect of their emotions.

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