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Two ways to lose all your money

Tony Yoo
·3-min read
A woman opening an empty wallet.
Two cognitive biases could be devastating for your wallet. (Image: Getty)

All investors, from mums and dads to sophisticated professionals, like to think they make money decisions rationally.

But humans are not rational and emotions creep in, even with the best intentions.

This is why massive rallies and shocking crashes in share markets happen – fear or excitement takes over.

Two psychological biases that could lose you a lot of money are commonly seen in investor behaviour.

Experts say you can be much wealthier if you can resist these two urges:

Investment enemy #1: Dunning-Kruger effect

The Dunning-Kruger effect is the tendency of people to not recognise their incompetence at something.

Such overestimation of one's own capability can result in big losses in investing, Stockspot founder and chief Chris Brycki told Yahoo Finance.

"As a newbie, I see people with just a little bit of knowledge suddenly think they're an expert," he said.

"They have a lot of confidence but that actually leads to big mistakes that can be quite costly."

The simple fact is that no one has a crystal ball and knows where the market or any particular company is heading in the future.

"They try to make a lot of money quickly – that's how movies like Wall Street make investing seem," said Brycki.

"But truthfully, it's very difficult to beat the market and consistently be a winner overall."

This is why it's best for beginners, or even veterans, to avoid speculating.

"That's the best way to dust your money pretty quickly," he said.

"It's better to drip feed money into something that's quite low-risk and diversify, where you are spreading your money across lots of companies."

Investment enemy #2: Anchoring

Anchoring is a very common effect seen all the time in every person in everyday life, not just investing.

It describes the cognitive habit of using the first-known information to compare all others that come after it.

For example, if a shopper first sees a smartphone on sale for $1,000, other shops that have it for $900 will seem a good deal. This is despite the $1,000 "anchor" being a completely arbitrary number, unrelated to the actual worthiness of the product.

A university study in the 1970s showed a group of people a roulette wheel stopping at either 10 or 65. The group were then asked how many countries in Africa there were.

Those who saw the roulette wheel stop at 10 on average guessed lower a number of countries than those who saw 65 come up.

Anchoring is notoriously difficult to shake off, but can be costly for investors.

Firstlinks editor Graham Hand this month recalled the anchoring effect on him when he was buying and selling Afterpay shares.

"Even professional investors have arbitrary rules for selling but a stock like Afterpay brings out behavioural biases when there’s not much else to cling to," he wrote.

"I remember thinking when I first sold 500 shares that it would pay for the initial 2,000 shares, covering me for whatever happened in future. The $14.87 sale in March 2020 was influenced by the $8 price a few days earlier, and the $49.45 sale was based on a notion of a $50 ceiling."

Investors have to keep reminding themselves to forget any earlier numbers and judge an investment purely on its merits.

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