Why do we sometimes make bad investment decisions?
InvestSMART’s Bootcamp course covers Investor Psychology and What tempts you to invest? and has helped many Bootcamp graduates.
Perhaps one of the more damaging psychological influences on investing is a phenomenon known as intermittent reinforcement, made famous by the behavioural psychologist BF Skinner.
Following Pavlov, who got his dogs to salivate at the ringing of a bell, Skinner found that rats would press a lever more often if they received a food pellet each time.
Noticeably, when the food pellets were only released some of the time, the rats went into lever-pressing overdrive.
Moreover, they observed that the rats found the behaviour much harder to give up.
You can see a powerful human application of this in the sprawling gaming empires of Las Vegas or Australia’s pokie-packed clubs.
For example, poker machine manufacturer Aristocrat Leisure spends tens of millions of dollars each year on research and development, refining more effective ways to trigger this effect in gamblers’ minds.
The intermittent reinforcement of unpredictable wins scattered among many losses makes poker machines so addictive. And this phenomenon also rears its head in the stockmarket.
Quick returns in the stockmarket will give you a similar rush to small wins on the poker machine.
Even more dangerous though, they could create a sense of overconfidence.
Inversely, a short-term loss when first investing may have you finding yourself second-guessing and even exiting the market.
Over time, successful investors learn to realise that investment returns can be sporadic.
Over the long term, it is the successful management of these emotions and managing things within your control that will have a much more significant effect on your investment results than jumping at short-term market movements.
What do we mean by this? First, keep a level head, understanding that investment returns don’t happen in a straight line, and have a plan.
Plan to add consistently to your investments over time. Sometimes you will add more cash when your investments are up and sometimes when they’re down. Stick to your plan, and you’ll conquer the psychological challenges of investing.
The InvestSMART Bootcamp will help you build your investment plan and highlight other psychological pitfalls when it comes to investing so you can avoid them and invest successfully for the long term.