As with all investing, timing is key. You only make money when you anticipate a market direction and get ahead of it. Unfortunately, our brains are wired so that we instinctively respond in the opposite direction. For some reason, behavioral
scientists keep finding that we all have an extremely strong preference for something we currently own. This preference usually appears clearly and powerfully irrational to a third party observer.
This behavior shows up in an endless array of money-losing financial decisions. When stock prices are in a bubble, stock holders usual hold on too long, believing that “their” stocks will keep going up. At that moment, their preference is for stock, which is doing well. And, when stock prices go down, stock holders tend to sell only near the bottom as they desperately try to preserve what capital they have left. By underperforming expectations, stocks are out of favor and capital is preferred.
As home buyers, we all believe our own homes are great and will always appreciate. Even during this last downturn, a stunning majority of us still believed that our homes would appreciate over the following 12 months. Probably the most egocentrically amazing finding is our common belief that our homes would hold up better than our neighbors! Even knowledgeable real estate professionals fall in to this trap.
The irrational investment behavior happens to most of us. I see it in my own investing behavior as well. Is there a solution? I tend to believe there is. Since a third party observer can dispassionately see the shift in preferences, the best way to avoid those pitfalls is to work with a trusted investment advisor. As an investment advisor myself, I also have an investment advisor to help monitor my own investment decisions. More than anything, trust is the key to success, since you need to have somebody you trust to call you on your emotionally charged investment mistakes. Having somebody with a strong financial background is a huge bonus. So, before making your next investment decision, swallow our very human pride and approach investing for the financial decisions game that it is. So, get some help to play the game well.