One of the most widely observed biases amongst investors is overconfidence. If you don't think you are overconfident about an investment decision, it's probably because you are overconfident.
We tend to think: Not only will the future be bright, but it will be especially bright for me.
This often leads to poor decision making and a bad investment experience for many. One way that we can seek to protect ourselves from episodes like, say, buying Irish Bank shares in 2007 is by asking these three simple questions.
Let's say it is 2007 and you are talking to the proverbial bloke in the pub who is waxing on about how much money he has made buying shares in Anglo Irish Bank and let's say that you have done a good job of saving and investing all your life and you are coming up to retirement. He says that this is a blue chip investment and a sure thing and that you should give up your boring globally diversified portfolio of low cost index funds and pile in.
Ask yourself this question: say you decide to follow this guy's "advice" and let's say he is right, will it really make that much difference to your life? You are already well off now, and looking forward to a comfortable retirement. Is the possibility of the gain really worth that much to you?
Ok, so now ask yourself a second question. What if you are wrong and Anglo is built on nothing more than cheap money and gambling? What is the downside to you? Can you afford to lose this much? Will you have to keep on working long after you had hoped to retire?
Now, ask yourself one final question - have you ever been wrong before?
By framing our decisions about investments like this, we can avoid some of the more damaging effects of our natural tendencies to make serious investment mistakes.
We tend to think: Not only will the future be bright, but it will be especially bright for me.
This often leads to poor decision making and a bad investment experience for many. One way that we can seek to protect ourselves from episodes like, say, buying Irish Bank shares in 2007 is by asking these three simple questions.
Let's say it is 2007 and you are talking to the proverbial bloke in the pub who is waxing on about how much money he has made buying shares in Anglo Irish Bank and let's say that you have done a good job of saving and investing all your life and you are coming up to retirement. He says that this is a blue chip investment and a sure thing and that you should give up your boring globally diversified portfolio of low cost index funds and pile in.
Ask yourself this question: say you decide to follow this guy's "advice" and let's say he is right, will it really make that much difference to your life? You are already well off now, and looking forward to a comfortable retirement. Is the possibility of the gain really worth that much to you?
Ok, so now ask yourself a second question. What if you are wrong and Anglo is built on nothing more than cheap money and gambling? What is the downside to you? Can you afford to lose this much? Will you have to keep on working long after you had hoped to retire?
Now, ask yourself one final question - have you ever been wrong before?
By framing our decisions about investments like this, we can avoid some of the more damaging effects of our natural tendencies to make serious investment mistakes.