Steadfast FinancesInvestor Psychology: Missing Out on Profits is More Frightening than Losing Money

Investor Psychology: Missing Out on Profits is More Frightening than Losing Money

Filed in Investing 101 , Investor Psychology 14 comments

I ran across an interesting bit of research today suggesting that one of the leading ways investors get suckered into investment bubbles, and subsequently decimate our annual performance, is that we are far too concerned with being left out of the money making process, rather than losing our original investment.

As one trading coach summed it up:

The prospect of regret [from not making money] is actually shown to be more motivating than the prospect of making money. So how that plays itself out is: well, my neighbor is in Google. I’m not making the money. I got to jump into Google now!

That’s the fear you’ve got to be on the biggest lookout for because that’s the one that will get you into bubbles at the worst possible moment.

– Denise Shull, CEO, The Rethink Group & Trader Psyches

[Fast forward to 2:20 minute mark]

This adds more fuel to the belief that there is still a largely unrecognized Behavior Gap among many investors in what we believe in our self deluded, confirmation bias clouded minds versus the actual rate of return we see on our quarterly balance sheets.

But what I find so intriguing is that this also lends more proof to the theory that our brains are programmed to follow the herd, and the real money makers are the iconoclastic personalities that can ignore the peer pressure, and/or make the investments that no one wants to make (e.g. take the path less traveled).

The Regret & Fear of Being Left Out

As Shull points out, it’s the regret of not making money that influences many of our poor investment decisions. But it’s also extremely difficult to ignore the desire to compete, or to make investing into some sort of competition — whether real in the case of professional money managers or a childish competition between neighbors — that may push you into bad investments that you might otherwise avoid.

For example, if the belief that your neighbor who already owns Google, might socially embarrass you by stating that he made a killing in Google while you’re the investing equivalent of Driving Miss Daisy, is so powerful that it would override your common sense not to buy, then you’re caving to the regret or fear of missing out.

In essence, the shortsighted belief that you may not be able to participate in the fun or celebration (e.g. making money) outweighs the fact that you may get punished later (e.g. losing money).

Sounds rather like high school… doesn’t it?

Like the time you knew it was a bad idea to ditch school, like all of your other friends, but you did it anyway because of peer pressure? Worse yet, to get the attention of a certain someone? Sounded good at the time, right? But man, did you regret it later.

That’s precisely what I find so astounding about the herding mentality and the efficacy of social leverage! You already know the herd is behaving irrationally. Yet, you’re willing to succumb to peer pressure, follow along with the herd to relieve that peer pressure, and accept that if you get hurt, at least everyone else will suffer the same fate as you.

Conquering the Fear of Missing Out

Maybe I’ve just seen too many investment bubbles in my 15 years of investing, or maybe I’m too antisocial to care about being part of the cool crowd, but nothing turns me off more about an investment (or anything else for that matter) is to find out that everyone else wants it or already owns it.

So from my point of view, the best ways to shield yourself from this “fear of being left out” phenomenon are:

  1. Stick to index funds. Many investment advisers, psychiatrists, and even a few neuroeconomists, will only invest in broadly diversified index funds because they don’t trust higher priced money managers to ignore their emotions and irrational feelings in order to outperform their benchmark index on a multi-year time line. In other words, they would rather pay low management fees to equal the market’s performance, rather than pay 5x to 10x to a professional money manager who may, but probably won’t, outperform the S&P 500.
  2. Ignore the noise. If you’re easily influenced by others, shut out as much of the white noise as possible. For example, don’t discuss your investments with others or avoid watching the daily business news. In no way am I suggesting you pull an ostrich and ignore the world around you, but if you’re susceptible to social leverage or peer pressure, learn how to tune it out when making financial decisions.
  3. Investing isn’t gambling. If the number one screening metric for your stock research requires looking for stock charts that go from the bottom left to the upper right, you’re basically gambling with a 50/50 chance of making money or losing money. True, you’re buying into a popular stock that everyone likes, but you’re also entering a crowded trade with lots of sharks who will sell at the drop of a hat to protect their profits. That means, you better be quicker on the sell trigger than they are!
  4. Pull the long term price chart. If XYZ investment has a stable rate of appreciation for many years, and suddenly triples in value in less than one year, chances are good you’re entering bubble territory. If you own already own XYZ asset, then look to cash in on your good fortune by capitalizing on this rare opportunity. Conversely, if you’re just catching wind of this investment idea after everyone and their brother has taken advantage of it before you, then it’s probably better to exercise patience, and remain on the sidelines. Knowing when not to buy is just as important as knowing when to buy in a bubble driven economy.
  5. Wait for the noise to die down. If “buy low and sell high” is an investment meme you follow, then why would you buy high and pray you can sell higher, rather than wait for XYZ to return to levels you feel more comfortable with. So perhaps, one of the best ways to avoid the “buy high and sell lower” phenomenon is to exercise some patience, pick your spots and use trending information, like Google’s Insights for Search, to make value driven investments when the buzz is low and only a small number of investors are buying.

In the end, I don’t think it’s feasible to suggest that one person, unless you’re some kind emotionless robot, can ignore their emotions every hour of every day. Perhaps the best thing to do is to realize that you’re human, acknowledge that you’re going to make the occasional mistake, but simultaneously do all that you can to minimize outside influences when it comes to your money management decisions.

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Posted by CJ   @   1 March 2010 14 comments
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Mar 1, 2010
8:06 pm
#1 Evan :

There is a lot of pain in watching a buddy making my yearly salary in a random penny stock! That being said, it hurts to watch the subsequent crash if they fail to get out.

Mar 2, 2010
4:13 pm
#2 ctreit :

Watching others make money is another case of keeping up with the Joneses. First, you don’t want to be left out when everybody is getting rich around you buying tech stocks or houses in the sunbelt. Somehow we think that it can’t be wrong when “everybody” is doing it. In fact, it is most likely a bad investment when everybody is in it. (Who is left to add money?) Second, you have a lot of pressure at social gatherings when everybody is talking about their latest financial successes and you got nothing to better the story. Who wants to be left out?

Mar 2, 2010
6:04 pm
#3 Monevator :

That’s pretty weird, because I’ve also read that actually losing money is worse than giving up profits… so presumably one batch of scientists is wrong! ;)

Mar 8, 2010
9:41 am
#4 Matt SF :

I’ve read conflicting data as well, but the study that I saw several years ago did not take into account the feelings *before* the investment was made. So investors/traders didn’t get the benefit on hindsight.

Mar 4, 2010
10:33 pm

I’m currently reading “Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich” by Jason Zweig. One of my fav WSJ writers. The book discusses this exact topic.

I want to write a blog post basically stating we are wired to be poor investors. We are way too short term thinkers and need too much social acceptance.

One skill I’ve learned over the years that has helped me become a better investor. Learn to weigh both the pro or con to investing in something.

If you are listening to the “noise” listen to both sides of the augment. Suck it all in digest both viewpoints. It definitely requires independent thinking. You might be doing things that are not very popular, but just because something is popular doesn’t mean it’s wrong either.

A perfect example of this is purchasing gold. Which side is right? Only time will tell in the long run.

Mar 8, 2010
9:51 am
#6 Matt SF :

Excellent decision making process! Perhaps someone should create an investment strategy where at least 2 out of 3 people must say “you’re a bleeping idiot to buy XYZ” as a buying signal. Definitely not for the short term trading minded, but it’s an interesting argument… at least academically.

Iconoclasts can usually drown out the verbal abuse and peer pressure, so maybe encountering high degrees of social anxiety is one (of many?) ways to know you’re buying in at the appropriate times.

Mar 7, 2010
6:55 pm
#7 Tracy :

Well put, Matt. Even I understood it, and I am not investment savvy at all. Isn’t this where bubbles come from though?

Mar 8, 2010
10:02 am
#8 Matt SF :

In theory, bubbles originate from a sudden spike in demand. Of course, there is speculation across the board that many bubbles are Wall Street fallacies artificially created to boosting short term profits. Jury is still out of course.

That said, bubbles also form by word of mouth, but in today’s world, words from a single person can be heard by millions. As you can imagine, that’s a lot of potential buyers if they choose to click the buy button. So if someone says XYZ is in high demand, everyone clicks buy (perhaps why some people refer to CNBC as “bubblevision”).

In a sense, it can be purely organic in the beginning, but it can also become a self fulfilling prophecy once enough people get wind that it’s an easy money maker. At that point, it will continue until more shares are sold than continuing to buy buy buy.

Hope that helps.

Mar 8, 2010
3:21 am

This is a pretty interesting study. But somehow, it makes you think that this is the primary reason why the bandwagon mentality is still very much applicable in today’s society, even if it has been said time and again, that when you see the bandwagon, you know that it’s already too late.

Mar 8, 2010
10:03 am
#10 Matt SF :

Well said. Unfortunately, most people can’t realize that very basic principle and pile on anyway. The thrill of making money is just too good not to pass it up.

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