Dipping into the world of finance and making regular investments is very important for people who are interested in the creation of wealth and wealth preservation. Investing itself has often been likened to gambling, making a strong gain on an investment can create the same kind of 'rush' as winning a hand of poker, and of course losing out in both fields will create a similar sense of dread and dismay.
As investments can have such an effect on the human mind, it's important to recognise the psychological impact, or rather the psychology of investing. Investigating the psychology of investing could give you a clearer image of why certain decisions are made, and can also help you overcome some negative thought that may be lurking in the nether regions of your mind.
An interesting area to examine is behavioural finance, which is the study of markets and financial practitioners and how psychology can influence them.
Over-confidence
Over-confidence refers to the human behavioural trait of having an enhanced idea of our own skills, knowledge or abilities. When over-confidence comes into a genuine sense that you are better than you actually are will cloud your judgement. A sign of over-confidence will be the rebuttal of ideas from your financial adviser. For instance, over-confident clients investors have been known to try and one-up advisers, and often refuse vital services such as a wealth review, unfortunately such behaviour can be a severe hindrance to your investment potential.
Loss aversion
Loss aversion is the practice of not paying attention to investments where you suffer a loss, and in turn only focussing on investments that make you a gain. Previous psychological tests have shown that a loss can have twice the affect on ones mind as a gain. Some investors have become so averse to making a loss that they will be not sell on shares even if there is the slightest chance of a tiny loss, and this could also have adverse effects on their future profits.
As with overconfidence there are signs for loss-aversion that can be spotted. A prime warning sign is the relentless pursuit of a product or prospect that may not give you the return you seek.
When building up an investment portfolio it's always important to discuss your ideas and plans with a trusted financial adviser. If you wish to get in contact with a recommended adviser, please fill out the Contact an IFA form.