CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71% of retail investor accounts lose money when trading CFDs with this provider (Saxo Bank). You should consider whether you understand how CFDs, FX or any of our other products work and whether you can afford to take the high risk of losing your money.

Delving further into Investor Psychology with Cognitive Dissonance

The idea that your investments can keep you awake at night.

One of the biggest issues investor’s have with their investor psychology is full portfolio management. Portfolio management can create issues if it causes stress and anxiety, which tends to migrate from work to the home. “Cognitive dissonance” occurs because of the need or desire to mentally justify previous decisions. This is true when the decision was controversial or finely balanced, or appears with hindsight to have been wrong.

In this instance the decision maker is likely to seek “additional justifications” to reduce anxiety or dissonance.

Dissonance: An instance of such inconsistency or disagreement.

At its worst, dissonance happens immediately with relatively small asset price movements. “Solutions” to stress and pressure needs to be tailored to the individual’s mental condition. It helps to identify its different elements.

It helps to identify its different elements.

Broadly, stress is caused by one or all of the following:-

a) Performance Anxiety (excessive scrutiny and fear of a negative outcome).
b) Perfectionism (the wrong assumption that you can get in at the bottom and out at the top).
c) Positive and negative self-talk (talking excessively about the subject matter usually with people who share your views).

Responses may be to do one or more of the following:-

a) Remain calm and focused on portfolio returns.
b) Eliminate perfectionist expectations by setting reasonable goals.
c) Ignore arguments or statements to the effect of what we “could have done” focus on what you are “going to do”.
d) Broaden other life interests – do not focus your entire energies on the pound note.
e) Conduct “a mental rehearsal” i.e. practise facing pretend situations to rehearse how you would like to respond.

Summary

Let’s start with a health warning, our sermonising might be in your best interest!

Investment management, understanding how companies work is a long and involved process that takes time. Many investors expect to obtain that expertise in a few weeks but in reality, it can take many years.

Even when that expertise is gained it is no guarantee to success.

It is a fast moving world and it creates a new normal. Few athletes win every single race, and many have long periods during their career without winning anything.

The same holds in portfolio investment, you need to be mentally prepared for low-return periods. This sort of thinking might help; “you will lose some battles, on the way to winning the war”.

“Black swan” events have challenged the conventional wisdom that prices respond quickly to big events. There may be shock or a delayed reaction over a period of time that will depress returns. One could see the period from 2001-2015 as populated with 3 distinct “bear” markets, 2000-2002, 2007-2009, 2014-2015. All of which were required to address the overvaluation of equities that took place at the turn of the century.

Evidence has shown that crises, by causing disruption, panic and over reaction brings opportunities for the patient. Frequent trading is often unprofitable, expensive and brings stresses and pressures that can apply to very experienced people.

It is worth understanding different factors, influences and how these trigger behaviours that may be out of proportion. Often the biggest investment returns occur by holding high-quality companies over a long period. Try to stand back from the rush.

It is vital to have the right expectations and sufficient faith in one’s own investment processes, as well as appreciating that investment biases exist that may impact your investment performance. If the investor is targeting a portfolio rate of return, this will eliminate disproportionate concern over individual positions. Do not let it stress you out; “make it your slave, not your master”, try de-stressing.

Got any further questions about these posts? Not sure of something to do with your portfolio

Alot of our readers have been sending us questions with regards to their concerns with their portfolios or mindset as a whole. So we thought we would offer the chance to get a question answered easily.

Simply complete the form below and someone will be in touch with you to help discuss any concerns you may have.

 

Enjoy your returns and be at peace with your results.

What is equity? It is the residual claim over assets after the repayment of debt and other claims. An investment in either a company’s debt or equity presupposes the company’s continuing health and viability. It also assumes that competent people are running the company.

The equity value whether a balance sheet representation or the market capitalisation (usually an exaggerated interpretation of that balance sheet equity) is likely to have little to do with the company’s ability to generate cash and meet its claims. It is important for investors to separate these facts without indulging in psychology or guesswork.

Psychology is a complex area, that is often integral to the decision-making process. It is important to recognise when it may be operational. Sometimes it may be a very key factor. Where the decision maker is under pressure to have an answer, psychological factors can be in the car, but should not be in the driving seat.

In recent years, investor psychology has taken a few knocks. This is partly due to a changing world, the arrival of a mass global media that often sensationalises corporate events and information.

It is important to appreciate that equity risk represents the residual value of companies.

 

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