Video Lesson
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Why Investors Behave Irrationally
Behavioral finance studies how psychology affects investment decisions. Research consistently shows that most investors earn significantly less than the market average — not because of poor stock selection, but because of emotion-driven decisions made at the worst possible times.
Loss Aversion
The pain of losing $1,000 is psychologically about twice as powerful as the pleasure of gaining $1,000. This causes investors to hold losing positions far too long (hoping to break even) and to panic-sell at market bottoms when the emotional pain is highest.
Overconfidence and Confirmation Bias
Overconfidence causes excessive trading and under-diversification. Confirmation bias makes investors seek out information supporting their existing thesis while ignoring contradicting evidence. Both consistently lead to worse outcomes than simply buying and holding a diversified index fund.
Recency Bias and Herd Mentality
Recency bias makes investors extrapolate recent performance into the future — buying at peaks after strong runs and selling at troughs. Herd mentality compounds this by causing investors to follow the crowd in exactly the wrong direction at exactly the wrong time.
Practical Strategies to Fight Your Biases
- Automate contributions to remove discretionary timing decisions
- Write down your investment thesis before buying
- Set rebalancing and sell rules in advance, before emotions kick in
- Check your portfolio less frequently — fewer decisions means fewer mistakes