How do humans choose stocks and other investments? We often fool ourselves and tend to get stuck.
In writing about behavioral economist Richard Thaler’s theories in The Washington Post, Barry Ritholtz points out that our brains were designed to survive in the wild but that while the stock market may seem wild, picking investments is very different from avoiding predators.
How many times have you heard the line, “There are two kinds of people in this world…?” For Thaler, those two types are “Econs” and “Humans.” Before you decide that you are one or the other, we should tell you that Econs are “the artificial constructs of how people are supposed to behave.”
Thaler offers non-investment scenarios as illustrations:
For example, did you ever order food, realize that it is not to your liking, and eat it anyway? Your rationale was that you paid for it and you cannot let it go to waste. This is a “sunk cost fallacy.” According to Thaler, instead of eating the food you don’t want, you need to let it go. Why take in calories to eat something you don’t want? The money has been spent whether you eat it or not…but few of us think this way. We are determined to reap all we can from our investments. Apply this idea to the stock market and it may be easier to understand why it can be difficult to let go of stocks that do not perform the way you expected.
Both Thaler and Ritholtz suggest that the best thing to do is try to get out of your own way. That may mean choosing investments and deciding to hold them for a certain amount of time rather than panicking. It may mean deciding to cut your losses instead of letting pride force you to hold on to investments that aren’t worthwhile. It could also mean getting the help of an impartial Fee-Only financial advisor who can take a more balanced view of your finances than you can.