Investment psychology is gathering greater attention in the finance industry. Just as professional athletes hire personal trainers to maintain their fitness, many top investors now consult psychologists and coaches to fine tune investment thinking. These services typically help investors avoid psychological pitfalls that can weaken even the most seasoned judgment – often with costly consequences.
Investment psychology might be more established among industry leaders, but its benefits reach much further than the top hedge fund traders. In fact, the right psychological tools can lead to smart investment decisions on all scales.
Are you curious about the psychological insights behind smarter investing? Keep reading to learn more.
Investment Psychology Encourages New Perspectives
In many cases, bad investment decisions arise from an excess of prudence – or an unwillingness to change one’s ideas. Wanting to make safe decisions that do not break with tradition, investors can resist adapting their ideas and strategies. Investments that ignore new information are bound to fail, or succeed only by pure chance. This is known as the ‘anchoring’ trap – the state of being anchored in one’s old thinking.
A variant of the anchoring trap, the ‘sunk cost’ trap adds personal value to the equation. Not wanting to acknowledge losses or abandon a hunch, some investors fall prey to sunk cost thinking, strengthening their resolve in the face of failure. The sunk cost trap is also known as the ‘Concorde fallacy’, so named after the supersonic passenger airline project. Despite long-term financial woes, Concorde’s British and French backers kept the project alive from 1976 to 2003, inadvertently coining an industry term for poor investment psychology.
Psychology Helps Investors Manage Uncertainty
Investment psychology is perhaps most essential in helping finance professionals manage risks. Market uncertainty can weigh heavily on the decision-making process, causing investors to drift into irrational and even superstitious thinking. Chief among these psychological traps, momentum-based thinking leads investors to misidentify trends. In the simplest terms, past random results cannot predict future ones. Falling to what is known as the ‘gambler’s fallacy’, investors misidentify likely outcomes this way.
Investment psychology helps students make clearer assessments of financial outcomes
Bachelor of finance graduates should think critically about their risk tolerance in all scenarios. Whereas financial success often leads investors to take fewer risks and protect their assets, financial loss typically leads them to embrace greater risks. Psychologically, this is explained by a tendency to protect winnings – and reverse bad fortune with one lucky strike. Yet, it is often more rational to embrace risks with a financial cushion and minimize risks after a loss. Investment psychology helps finance pros realign their thinking and avoid these strategic mistakes.
Investment Psychology Helps Finance Pros Become Better Collaborators
Investment psychology helps industry professionals become better employees, eliminating the risks they might otherwise pose for their companies. This insight also helps investors avoid psychological trappings in joint decision making. A common trap is the false consensus fallacy, whereby investors overestimate the extent to which others agree with their conclusions. Avoiding false consensus means seeking honest opinions and weighing all the options.
The insights of investment psychology can help students make more informed career choices
Investors can also fall prey to superiority complexes, assuming recent successes imply higher market knowledge or intuition. In addition to poor decisions, this thinking can lead to strained work relationships and diminished collaboration. As the top investors know, no one holds all the market’s secrets, and successful professionals around the world share a tireless drive to learn and adapt their knowledge to new financial scenarios. While pursuing careers after their international finance degree, students are advised to nurture their drive for learning and collaboration.
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