Investment Fallacy: Common Mistakes in Investing
Investing is one of the most effective ways to build wealth in the long run. However, many investors, both beginners and experienced ones, often fall into various thinking errors known as investment fallacies. These mistakes can lead to poor investment decisions and significant financial losses.
In this article, we will discuss the various types of investment fallacies, why they occur, and how to avoid them to become a smarter and more rational investor.
What is an Investment Fallacy?
An investment fallacy is a thinking error or cognitive bias that affects investment decision-making. These biases often stem from misperceptions, incomplete information, or emotions influencing decisions.
Many investors fall into these traps because they rely on intuition or follow market trends without deep analysis. Below are some common mistakes that often occur in investing.
Types of Investment Fallacies
1. Sunk Cost Fallacy
The sunk cost fallacy occurs when someone continues to hold on to a poor investment simply because they have already spent a lot of money or effort on it. In investing, this mistake is often seen in the form of holding onto stocks or assets that have significantly declined in value, hoping that the price will recover.
Example: An investor buys a stock for Rp10,000 per share, but then the price drops to Rp5,000. Feeling reluctant to accept the loss, they continue holding the stock even though the company’s fundamentals have deteriorated.
How to Avoid It: Investment decisions should be based on future prospects, not past costs. Evaluate assets objectively and do not let emotions control decisions.
2. Confirmation Bias
Confirmation bias occurs when investors only seek information that supports their views while ignoring contradicting information. This can lead investors to overlook risks and stick to bad decisions.
Example: An investor believes that gold prices will continue to rise. They only read news and analysis that support their view and ignore data showing a potential decline in gold prices.
How to Avoid It: Make it a habit to seek different perspectives before making a decision. Analyze from various sources and consider opposing arguments to gain a more objective view.
3. Recency Bias
Recency bias is the tendency to place greater emphasis on recent events while ignoring long-term trends. This bias often makes investors believe that ongoing trends will continue indefinitely without considering market cycles.
Example: If the stock market has been rising for the past few months, investors may assume that this trend will continue and ignore the possibility of a market correction.
How to Avoid It: Look at historical data and understand that markets have cycles of ups and downs. Do not rely solely on recent trends, but conduct a thorough analysis before making investment decisions.
4. Overconfidence Bias
Overconfidence bias occurs when investors are overly confident in their ability to select profitable investments. This bias can lead to excessive risk-taking without adequate analysis.
Example: A beginner investor who recently made a significant profit from one investment might believe they have special skills in stock selection. As a result, they ignore risks and invest in highly risky assets.
How to Avoid It: Stay humble and always conduct in-depth research before investing. Do not rely solely on intuition or luck, but use data-driven and analytical strategies.
5. Herd Mentality
Herd mentality is the tendency to follow other investors’ decisions without conducting independent analysis. This often leads to market bubbles or panic selling during price drops.
Example: When Bitcoin prices rise drastically, many investors buy in due to fear of missing out (FOMO), without considering whether the asset’s valuation is reasonable.
How to Avoid It: Do not blindly follow market trends without a clear understanding. Always conduct independent research and assess whether an investment aligns with your financial goals.
6. Gambler’s Fallacy
The gambler’s fallacy is the mistaken belief that past events influence future outcomes in situations that are actually random.
Example: An investor notices that a particular stock has dropped for five consecutive days and assumes that it will surely rise the next day simply because it has been falling continuously.
How to Avoid It: Understand that stock price movements are influenced by multiple factors, not just past patterns. Use fundamental and technical analysis to assess investment potential.
How to Avoid Investment Fallacies
To become a smarter and more rational investor, consider these steps:
- Use Data and Analysis: Always conduct thorough research before making investment decisions. Use historical data and fundamental analysis to understand an asset’s prospects.
- Create an Investment Plan: Set clear investment goals and strategies. Avoid making decisions based on emotions or short-term trends.
- Evaluate and Self-Correct: Continuously review your investment decisions and learn from past mistakes. Do not hesitate to acknowledge errors and take corrective actions.
- Diversify Your Portfolio: Do not put all investments into one asset or sector. Diversification can help reduce risk and increase potential returns.
- Control Emotions in Investing: Manage emotions such as greed and fear, which can cloud objective judgment.
Conclusion
Investment fallacies are thinking errors that frequently occur in the investment world. From the sunk cost fallacy and confirmation bias to herd mentality, these mistakes can lead to poor investment decisions and financial losses.
By understanding and recognizing these biases, investors can make more rational, data-driven decisions. Always conduct in-depth analysis, control emotions, and adhere to planned investment strategies to achieve long-term financial success.
