Why We Make Poor Investment Decisions and How to Avoid Them

After an event, we often analyze it in detail, thinking we know exactly what should have been done. You’d think this would make us better at making decisions, especially in investing, but it doesn’t. We keep making the same mistakes. Behavioral scientists say we’re not great at making informed decisions, and this is especially true for investing. Here are some common patterns that lead to poor investment choices.

Focusing on Outcomes, Not Processes

People love to talk about their big wins, like buying a stock that skyrocketed or avoiding a market crash. However, they rarely discuss the process behind these decisions. If you can’t repeat it, it’s likely just luck. Yet, investors often believe that one or two successes mean they’ve got it figured out. This leads to reliance on tips, tricks, and patterns that might not actually work.

Glorifying Lucky Breaks

Stories of people making big money from lucky investments become legends. These tales make others believe they can do the same. Each bull market has its own narrative and jargon, making people think they’ve found a foolproof method. This creates a false sense of competence, leading to more poor decisions.

Social Influence and Fear of Missing Out

Seeing others make money makes investments seem like a good idea. In a bull market, early investors make gains, attracting more people who don’t want to miss out. This social proof creates a sense of urgency and confidence. People end up investing in poor-quality IPOs and ventures just to be part of the trend.

Overloading and Misusing Information

There’s a lot of information out there, and it’s hard to sort through it all. Investors struggle to trust the data and opinions they see. They often use information selectively, seeking out data that confirms their existing beliefs. In a rising market, recent gains seem more relevant than long-term market cycles, leading to decisions based on short-term trends.

What to Do Instead

A simple strategy like buying and holding a market index fund long-term works well for most investors. However, this approach seems boring compared to picking stocks and constantly trading. People want to believe they can outperform the market, but consistently doing so is extremely difficult.

Investing is often seen as a series of active decisions—buying, selling, and adjusting portfolios. This activity seems dynamic and smart, while a long-term, simple approach seems dull. As a result, poor investment decisions continue. We complain about bad outcomes but then repeat the same mistakes.

To avoid poor investment decisions, focus on a long-term, simple strategy. Be wary of stories of quick riches and social pressures. Trust data and processes over short-term outcomes. Remember, sometimes boring is better.