The Role of Psychology in Investment

The role of psychology in investment is often underestimated by lots of people, even knowledgeable investors, because they are simply not conscious and aware of its importance on an investor’s decision making

The role of psychology in investment is often underestimated by lots of people, even knowledgeable investors, because they are simply not conscious and aware of its importance on an investor’s decision making

Needless to say, psychology is one of the key elements in investment.  Yet, the role of psychology in investment is often underestimated by lots of people, even knowledgeable investors, because they are simply not conscious and aware of its importance on an investor’s decision making.

If you are an investor in Singapore and you would like to know more about this topic, below are two interesting and valuable concepts that would help you steer clear of incorrect and inappropriate investment choices:

Loss Aversion

So hold on, here comes a remarkable experiment. If you are to select between:

A) a little loss, and

B) a 50-50 chance to have a consistent loss or to break even.

Which of the two options will you select?

Here’s another interesting query: Supposing, instead of a loss, it will be between:

A) a small profit, and

B) a 50-50 chance to have a bigger profit or to break even.

At this point, which options will you select?

If you’re just like the majority of the people, you would have selected the second option (i.e. option B) in the first question, and the first option (i.e. option A) in the second query.

This inclination for “certain gain” and “uncertain losses” is customary among investors in Singapore and other parts of the world. As such, this also explicates why certain investors usually “double down” on investments where they have incurred losses while they are normally rapid to “sell out” on investment instruments where they have generated profits.

Mental Accounting

Mental accounting is none other than investors’ propensity to mentally position objectives into diverse “categories” or groups.  Consequently, they allot diverse pieces of their wealth to achieve such objectives.

A typical example of this is the following: assuming you wish to make two significant purchases, a lap top and a video recorder.  Instead of evaluating your entire wealth and settling on whether there is really a need for such items, people endowed with mental accounting would prefer to split their wealth and allocate money to each objective.  In other words, it is like having two distinct savings pot labelled “Lap Top” and “TV”. These investors would then make the purchase the time in which one of the pots has accrued enough money for the given item.

Mental accounting usually gives way to poor allocation of investment resources. Nevertheless, it is an effective manner to inculcate discipline, will power and strength of mind.  By means of convincing yourself to set aside a given amount of your savings so as to obtain a specified goal (e.g. recompensing your credit card, house and lot mortgage, children’s university fees),  you are prompted not to use up that money and are likely to attain that goal.

Have you learned something from this?  Delve into the topic and read other noteworthy articles HERE.

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