Still kicking yourself over staying too long in the market — or for pulling out too soon? Ease up. John R. Nofsinger, author of Investment Blunders (of the Rich and Famous) and What You Can Learn from Them (Financial Times/Prentice Hall), says some investing screw-ups are the result of good ol’ human nature.
AW: Your field is “behavioral finance.” Please define.
JN: People don’t always behave rationally when trying to maximize wealth. So we look at what happens when feelings and psychological biases get involved in financial decision making.
AW: Why do we do let emotions mess up our investments?
JN: We want to feel good about ourselves. If we sell a losing stock, we have to admit that we picked a loser.
AW: You also warn against seeking patterns in the market. But isn’t that a logical thing to do?
JN: There’s no theory or reason to believe that what has happened before will be projected forward. These things are random.
AW: What is “anchoring,” and why is it a problem for investors?
JN: Suppose you buy a stock at $10, and it runs up to $90. Then it starts to drop. Instead of selling and taking a nice profit at $45 or so, you set an emotional anchor at $90 and hope you’ll get back there.
AW: So it’s possible to be too optimistic?
JN: Yes. Optimists will succumb to certain emotions more than pessimists will. It doesn’t take much convincing to convince an optimist. Oddly enough, being in a bad mood can make you more analytical.