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This Issue
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COMMON INVESTMENT MISTAKES
The primary problem investors have is ... themselves. Basic human tendencies get in the way of allowing the market to work for us. Virtually everyone has bouts of pessimism and over-confidence. The average growth on earnings between the years 1982-1997 was approximately 7.58%. However, predictions by analysts of the market averaged 22% and even the conservative minded Wall Street economists predicted 17%.
It is interesting to note that the "experts" were not only considerably wrong in their predictions, but they were consistently wrong ... and they do not improve with time.
Looking back to the Second World War ... every "crisis" that has occurred, i.e. Berlin blockade, Persian Gulf War, etcetera ... has resulted in the stock market recovering very well. One year following the "crisis" the Dow Jones Industrial Average bounced back to increase by and average of 28.8% and two years later the average was 37.5%.
History has shown that is a mistake to sell at the time of a crisis because people have a tendency to over react ... it is human psychology and emotions that make us react illogically.
Emotions can come into play and cloud the thinking of even seasoned professionals. Add to this the fact the humans tend to rely on intuition that is often invalid. Consider, people who are asked to evaluate the odds that any 23 people might share the same birth date ... a majority of them say 5% to 10% ... in reality it is 51%. People often underestimate the number of times random patterns occur and thus tend to over react to the ups and downs of the market.
Distorted thinking accounts for many mistakes ... for example, when asked, "What is more common, murder or suicide" most people (70%) say murder is more common. In reality, there are approximately three suicides for every two murders in America. Probably people assume this because the media reports many more incidences of murder than suicide. In the same way, people read headlines that highlight market drops but not the typical small, daily gains that eventually add up.
Fear-of-loss is another powerful factor that can dominate ones thinking ... it has been said that the intensity of emotion that we feel when losing money is approximately twice as much as the happiness we experience from making it.
Rationalization accounts for much overconfidence because we tend to accept ideas and facts that support our viewpoints ... and, at the same time we filter out the information that does not "fit" with our preconceived ideas. This often results in treating random events as though they can be controlled. Finally, markets are difficult to predict with certainty and therefore investing should be made with the idea of "playing the odds". Diversify and allow time to take it's coarse.