Investing psychology Investment tips: Caution! Investor traps!

Some investors let themselves become guided by their emotions. Fight your gut instinct: our investment tips based on psychology.

by UBS Insights 24 May 2018

The relatively new science of behavioral economics of financial markets (behavioral finance) uncovers partially irrational behaviors that could have a negative financial impact on emotional investors. Four examples of psychological investor traps.

Availability heuristic

The more often we noticed something happening in the past, the more we think it could happen in the future. In other words: something we haven't noticed happen yet is not likely to happen in the future, according to our own estimates.

However, as the frequency of our perceiving something is based on the frequency of reports and not on exact measurements, the availability heuristic is a poor advisor. Instead, you should base your decisions on careful analysis.

Hindsight bias

Successful investments are often associated with talent, unsuccessful ones with misfortune. We tend to overestimate the predictability of an event that has surprised us and say “well, I could have seen this coming.”

To avoid such false memories, keep an investment diary. It’ll allow you to understand investment decisions and learn from miscalculations.

Making money requires strategy

Read in the interview with Daniel Kalt, Chief Economist and Regional Chief Investment Officer Switzerland, why alternatives to savings accounts might be worth examining.

Bandwagon effect

Demand for a security only goes up because others are also buying it. Of course, you want to profit just as others are doing. We are magically attracted to trends.

The fine print of many finance publications says that one shouldn't use past performance to draw conclusions about future performance. Here, too, the rule is: buy based on a serious analysis or well-founded advice.

Anchoring effect

It happens again and again that we let ourselves be influenced by absolute numbers that act as an anchor or magnet, for instance the threshold of 25,000 for the Dow Jones. However, what is relevant in such a case is not an absolute limit but the change in percentage within a specific time frame.

Don’t fall into the absolute numbers trap; focus instead on the factors behind the anchor values and changes. That way you’ll avoid another investor trap.