The Psychology of Investing: Why Smart People Make Dumb Decisions

Don't get me wrong, you can understand compound interest, diversification, and market fundamentals and still make terrible, (even horrible, I'd say) investment decisions. The reason is that investing isn't done by spreadsheets alone. Real people make decisions while experiencing fear, excitement, impatience, and uncertainty. However, you can too. Knowing what you should do and actually doing it are two very different things. Make sure you act upon the things that you know are right, not trends or emotional in-the-moment decisions.

I'd Try to Remove Fear

Losing $1,000 doesn't usually feel like the same experience as gaining $1,000. Investors tend to feel losses more intensely than equivalent gains, which can lead them to make decisions based on avoiding pain rather than pursuing their long-term goals. When investing, you must have an open mindset and just plainly accept that you will eventually lose money. For example, during a market decline, selling might seem like the safest option, but in reality, nothing about your long-term plan has changed.

Trust me, a market decline isn't necessarily the same thing as permanently losing your money, though some make the mistake of having that thought. If a diversified investment falls because the overall market is having a bad period, selling locks in whatever price exists at that moment, while cutting you short of the potential when it rises again. The investor then has to decide when to buy back in, which is another difficult decision. One of the most common mistakes is to buy the stock when it has already gone up, which is exactly the next point.

FOMO Makes People Chase Unnecessarily

Fear doesn't always make investors sell. Sometimes it makes them buy, which to me is interesting. When everyone around you seems to be making money from a particular investment, it can feel like you're missing an obvious opportunity. The massive problem is that an investment that has already risen dramatically isn't automatically a good investment at its current price. Especially with social media and influencers, this can be an extremely powerful force you are trying to resist, because everyone else says it is only going to keep going up. 

People naturally give more weight to what has happened recently. If stocks have risen for several years, investors can start believing that markets will continue rising forever. If stocks have fallen for months, they may assume things will keep getting worse. Neither assumption is necessarily correct.

Overconfidence Can Be Just Dangerous

After making a few successful investments, it's easy to start believing you are better at investing than you actually are. A lucky decision can often feel like skill, especially when the investment goes up immediately afterward. Overconfidence can lead investors to take larger positions, trade more frequently, or believe they can consistently predict what the market will do next. Instead, to combat this, rewire your brain to have confidence in your strategy, but also accept that you can´t predict the future.

Once someone becomes convinced that an investment is going to succeed, they naturally tend to notice information that supports their opinion and ignore information that challenges it. One of the most acclaimed investors of our time, Ray Dalio essentially says that you need to always be searching for improvement. So don't make the mistake of being that investor might spend an hour reading positive predictions about a company while dismissing every warning as irrelevant. Comfirming your facts leads nowhere.

Selling before a crash and buying before a recovery sounds like the perfect strategy. The problem is that you have to correctly predict two separate moments: when to get out and when to get back in. Missing even a relatively small number of strong market days can significantly affect long-term results. 

Having a Written Plan Can Protect You From Yourself

One of the best ways to deal with emotional decisions is to make important decisions before emotions take over. An investor can establish rules for how much money they will invest, what they are investing in, how diversified they want to be, and what their goals are. Then, when the market becomes frightening or exciting, they have something to return to instead of making a completely new decision in the moment. I'd honestly just take a couple minutes to just write down your goals, strategy, and short roadmap. 

Control Your Emotions

Remember, nobody becomes completely emotionless just because they understand investing. Fear during a major market decline is normal, and excitement during a bull market is normal too. The goal is to recognize those emotions without automatically allowing them to control your decisions. For a young investor, learning to stay disciplined through both good and bad markets may be one of the most valuable and essential investing skills you can develop.