Investor psychology – a misunderstood an underestimated problem

Selecting and buying stocks for a portfolio is not easy. When discussing portfolio selection Markowitz stated that the process of selecting a portfolio could be divided into two stages.

  1. The first stage starts with observation and experience and ends with beliefs about the future performances of available securities.
  2. The second stage starts with the relevant beliefs about future performances and ends with the choice of the portfolio.

Using this approach the selection and purchase of an investment portfolio seems logical and straight forward and the investor evaluates the risk of investing based on observation and experience by considering a range of variables including inflation, interest rate movement, the economy etc. The investor should then be in a position to buy the stocks for the portfolio. But this is the problem stage because people are rarely rational in their decision making when it comes to investing. For example after a significant… Continue reading

The uncertainty of equities

There is the old adage that “investing is simple but it is not easy”. This is very appropriate because while investing per se is not difficult, investment decisions are always made in the light of uncertainty and investors do not handle uncertainly well.

Consider the Australian market which has about 2000 stocks. Some of these stocks have sound fundamentals while others are speculative and do not pay a dividend. Some stocks have rapid rates of share price increase while others show significant losses. Also, there is too much choice and there is also the problem that there is often little correlation between the intrinsic value of a stock and its performance over the short and medium term. These things considered it not surprising that more than 60% of investors in the stock market lose money.

But the problem of handling uncertainty is not simple because in making an investment decision… Continue reading

Human emotion is the biggest enemy of the investor.

Human emotion is the biggest enemy of the investor.  I have been very bearish about this market for some time and this poses the risk of missing the next bull market and I need to constantly re-examine my attitudes to the market.   So I am always aware of the problems of psychology which can cause me to miss a profitable rally.

It is crazy to invest on the basis of a gut feeling or a hunch.  Currently we are in either a bull market or a bear market correction depending on your view.   But either way there is little doubt that this is a market that the investor needs exposure to simply because of the increasingly low returns from cash and fixed interest:  but you have to do your homework.  My approach is as follows.  There are… Continue reading

Why do we seek financial advice?

I have always wondered why intelligent people spend a lifetime accumulating assets and when they retire, invest those assets on the advice of a financial “expert” without appropriate due diligence. Worse still, many people simply place their assets under the control of a financial professional.

We are all aware of extreme examples of professional ineptitude or dishonesty such as the Bernie Madoff scam and we would hope to avoid getting involved in that sort of investment scheme. But why do we place so much confidence in our brokers, financial advisors and fund managers?

It is well established that most fund managers fail to beat the market index and yet investors continue to use these failed managers and in general the other financial experts are no better.

Upon psychological analysis it seems that the reasons why we blindly use flawed financial professionals are simple. If I seek advice I will eventually… Continue reading

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