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Steve's Newsletter

Steve's July 2021 Newsletter

Investing and your Brain!

There is a lot more to investing then reviewing corporate balance sheets and income statements. Investors gather historical data to predict future return and the amount of risk they want to take. No matter how much information is gathered or the complexity of the investment process, there isn’t one rule that works all the time. It's complicated and it's not easy! Surprisingly, a lot of investing decisions; both yours and mine involve Behavioral Psychology.

When I first started investing and later became a Financial Advisor, Modern Economic Theory was king! It simply concluded that human beings are very rational when making financial decisions. Visualize Warren Buffet in 1985, analyzing thousands of pages of financial data and then buying a business based only on that information.

In the last decade, Behavioral Finance Theory has become prevalent. It says human financial errors are predictable, common, and usually arise from cognitive and emotional biases.

Some Common Investing Behavioral Finance Biases:

Loss aversion bias: We react differently to gains and losses. The pain experienced from investing losses is much greater than the pleasure we get from similar gains. This can lead to selling winners too early for a small profit or selling during market downturns to avoid losses.

Confirmation bias: We validate incoming information that supports our preexisting beliefs and reject or ignores contradictory information. In other words, it is seeing what you want to see and hearing what you want to hear. As investors, we are prone to spending more time looking for information that confirms our investment idea or philosophy. This can lead to holding on to poor investments when there is clear contradictory information available.

Hindsight bias: We convince ourselves that we made an accurate investment decision in the past which led to excellent results. This can lead to overconfidence that our investment philosophy works all the time. On the flip side, hindsight can lead to regret if we missed an opportunity. "Why didn’t I buy more at the market low in March 2020?"

Recency bias: We emphasize or give too much weight to recent events when making decisions and give less weight to the past. This causes short term thinking and allows us to lose focus on our long term investment goal. It essentially explains why investors tend to be more confident during bull (up) markets and fearful during bear (down) markets.

Since we're all human our brains cannot eliminate these biases; however, by understanding them we can all avoid there pitfalls, both in life and financial decisions. At Newmarket Advisors, Inc., I think long term and try not to let short term noise; emotions or recent events impact the process of guiding you to reach your financial and life goals. I build and rebalance diversified portfolios across different asset classes to produce the best risk adjusted returns for you to meet your retirement goals; through calm and turbulent markets!

Have a Great Summer!  

Steve Newman