Why We Tend to Trick Ourselves into Making Bad Trades – Presented by Mark K. Lund, Utah Financial Advisor

Financial Advisor Utah

Hans Christian Andersen recorded a folktale about a poor farmer who takes his horse to market to sell or exchange for something that will be more practical for his farm. But on the way to his destination, the Old Man (as he’s known in the story) makes a series of ill-advised trades. In each case he makes a swap for something of lesser value until, ultimately, he has traded his horse for a bag of rotten apples.

His saving grace is that when he gets back home his wife doesn’t scold him but instead says, “What the Old Man does is always right.” This mild response wins a bet the farmer has with two Englishmen who had wagered a bushel of gold that he would get clobbered.1

In addition to the lesson about supporting your spouse when they make mistakes, the folktale also illustrates how emotions can cause people to use poor judgment when making trades. In each of his lopsided deals the Old Man always has what seems like a very practical reason for making the exchange.

Taylor Tepper, a financial journalist for Forbes, writes that when the vast majority of us try to trade stocks for short term gain, we do a horrible job. “We sell them when we should buy,” he says, “buy when we should sell, and are overly influenced by the noise around us.”2

The problem, as multiple studies have shown, is rooted in our psychology. Our innate bias in favor of our own abilities and our aversion to loss work against us when we determine when to make trades.

One psychological bent that behavioral economists have identified is known as Prospect Theory. It’s the irrational belief that something that has lost value is sure to regain it soon. This behavior stems from our aversion to loss and results in holding onto declining assets when the rational choice should be to cut our losses.

A related phenomenon is known as Mental Accounting. This is the tendency to stash different types of gambles into completely separate mental accounts. As a result, we tend to judge each wager by its own rules, leading us to make special exceptions in contrast to logical decision making.

It’s hard enough to try to beat the market. And when your emotions get in the way of a methodical strategy, your chances of coming out ahead are very low.

This is why Meir Statman, professor of finance at Santa Clara University and someone who has studied investor bias for decades, says investors are not wise to buy individual stocks for two reasons. First, they lose out on the benefits of diversification. Second, trying to beat the market can produce a lot of anxiety.

“I learned to shrug my shoulders when markets go up or down,” says Statman. “Wise financial behavior and good exercise.”

The prudent investor understands the best way to pursue potential long-term gains in global markets is to stick with a diverse portfolio guided by evidence rather than emotion. And the best way to accomplish this is with the help of a trusted advisor.

If you ever have any questions about your investments or retirement plans, please feel free to give me a call at 801-545-0696.

Regards,
Mark Lund
Stonecreek Wealth Advisors, Inc.
11576 S State Street, Bldg. 1002
Draper, UT 84020

Sources:
1. http://go.pardot.com/e/91522/atTheOldManDoesIsAlways-e-html/93rvry/2065152088?h=OyBI2wLpJPedwzThm2EjtdiTDOKsjwhrv8m-4BEWTNw (also known as “What the Good Man Does Is Always Right”)
2. http://go.pardot.com/e/91522/psychology-investment-returns-/93rvs2/2065152088?h=OyBI2wLpJPedwzThm2EjtdiTDOKsjwhrv8m-4BEWTNw

Disclosure:This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by Efficient Advisors, LLC (“EA’) for Mark Lund, Mark is a Financial Advisor in Utah. He is known as a Wealth Advisor, The 401k Advisor, Investor Coach, Financial Planner, Investment Advisor and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. a fiduciary, independent, fee-only, Registered Investment Advisor firm providing investment management and retirement planning for individuals and 401k consulting for small businesses. Mark’s newsletter is called The Effective Investor Newsletter. Cities served in Utah are: Salt Lake City, Salt Lake County, Utah County, Park City, Murray City, West Jordan City, Sandy City, Draper City, South Jordan City, Provo City, Orem City, Lehi City, Highland City, Alpine City, American Fork City. The views expressed herein are exclusively those of Efficient Advisors, LLC (‘EA’), and are not meant as investment advice and are subject to change. All charts and graphs are presented for informational and analytical purposes only. No chart or graph is intended to be used as a guide to investing. EA portfolios may contain specific securities that have been mentioned herein. EA makes no claim as to the suitability of these securities. Past performance is not a guarantee of future performance. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.

Category: Blog, Newsletters

About the Author ()

Mark K. Lund is the author of The Effective Investor, a #1 Best Seller, and founder of Stonecreek Wealth Advisors, Inc. an independent, fee-only, Registered Investment Advisory firm. He has provided articles for or been quoted in: The Wall Street Journal, The Salt Lake Tribune, The Enterprise Newspaper, The Utah Business Connect Magazine, US News & World Report, and Newsmax.com, just to name a few.  Mark publishes two newsletters called, “The Mark Lund Growth Report” and “Mark Lund on Money.”  Mark provides CPE (continuing professional education) courses for CPAs.  You may also have seen him on KUTV Channel 2, or as a guest speaker at a local association or business. Mark provides investment and retirement planning services for individuals and 401(k) consulting for small businesses. In his book, The Effective Investor, Mark exposes the false narrative magazines, media, big Wall Street firms, and most advisors want you to believe. The good news is that Mark will show you that you don’t need their speculative ways of investing in order to be a successful investor. Get a free copy when you schedule your initial consultation.

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