by Ingrid Case

From economic forecasts to market reports, the morning newspaper provides much of the information you need to understand the critical forces acting on your investments. But consider this: That same paper fails to cover the most important person influencing your portfolio’s performance. Even more shocking, we’re talking about someone you come face to face with every day.

That’s right, we’re talking about you.

When it comes to investing, most of us have a common set of behavioral fallacies. Think of them as a set of psychological tripwires that lead to irrational investment decisions—decisions based on short-term emotions rather than long-term logic.

Understand your behavioral fallacies, and you might improve your chances at investing success, says Jim Dier, director of equity quantitative research at Thrivent Investment Management. “If you’re using logic and working with a skilled professional, you should be able to do better than someone who thinks he or she can go it alone and is basing decisions on luck and emotion.”

Ready to get rational? Read on as we explore some of the most common financial fallacies—and, most important, potential fixes.

Self-Attribution Bias

Like backyard golfers who believe they’re just a reliable putter away from the Masters, many investors believe they are unsung financial geniuses. They credit themselves for successes and blame losses on others or “just a little bad luck,” a malady known as self-attribution bias. If you patted yourself on the back as your tech fund gained 20 percent in one year, then blamed a 20 percent loss the next year on corporate management, you’ve been susceptible to this.

Investors with self-attribution bias generally are overconfident and tend to invest only in areas where they think they have special knowledge. This means their portfolios are not appropriately diversified and are exposed to unnecessary risk.

You’re a smart investor, but you’re not a professional investor. You’re responsible for both your portfolio’s successes as well as its failures, so it behooves you to work with a pro. And stay focused on the big picture. For instance, from 1926–2004, average annual growth in the U.S. stock market has been 10.4 percent. You’re not going to beat that on your own.

Instead, diversify your portfolio and invest for the long term. No matter what kind of specialized knowledge you think you have, Dier says, “there are other kinds of investments that can reduce your risk while increasing your return.”

The pros can help you design an investment strategy that will serve you in a variety of situations. After all, with all the smart people in the world, why not get some of them on your side?

Gambler’s Fallacy

If you say it’s more likely to come up tails, you’re a victim of gambler’s fallacy. In truth, any coin toss presents a 50–50 chance of either heads or tails, regardless of what the last throw—or the last 100 throws—produced.

In investing, gambler’s fallacy victims say the market will head down after it’s been up for a while, and go up as soon as it’s been down. The market eventually changes direction, of course, but having a sense of when is something difficult even for an expert to evaluate, says Marcus Winbush, divisional sales manager for investments with Thrivent Financial. “It takes a highly skilled expert years to navigate market volatility,” he says. “It’s not something you can figure out over your Sunday newspaper.”

Knowing the market’s next move is crucial only if you’re timing the market—a fool’s game that involves holding investments for as little as a few hours based on short-term
market predictions. If you’re day trading, stop. According to an independent study commissioned by the North American Securities Administrators Association and publicized by the Federal Trade Commission, more than 70 percent of day traders lost everything they invested.

Instead of trying to hit a home run, swing for singles. Build a portfolio that relies on quality investments, diversification and a long-term investing horizon. Choose investments that, as a group, will ride through the market’s inevitable changes.

“If your goal is finding good investments,” Dier says, “market timing becomes much less important.”

Outcome Bias

It’s one of life’s basic lessons: discontinue strategies that lead to losses and repeat those that bring reward.

But sometimes even the worst strategy can result in reward, and when this tempts you to continue the strategy, it’s called outcome bias. Over the course of one year, one investor might reap a 20 percent return investing only in mutual funds that begin with the letter S. Over that same year, another with a well-diversified portfolio might gain just 5 percent. If you’re tempted to use either of these short-term results as the basis for a long-term strategy, you’re suffering from the nearsightedness of outcome bias.

A backyard fence is a do-it-yourself project; a retirement plan is not.

“A financial professional can help you understand where your strategy is succeeding, where it’s failing, what part luck has played and what you need to change,” says John Aakre, a Thrivent Financial senior financial consultant in Olympia, Washington.

Most of all, you can’t measure success or failure by a single, short-term set of results. Instead, you have to measure success over decades of results.

“I tell my clients that the bulk of their money should be in a well-diversified portfolio of investments. This is the real money that your family will rely upon in the future—
not Monopoly money,” says Aakre.

Loser’s Fallacy

Many people overreact when an investment loses money. They sell the investment immediately, without giving it a chance to regain value. Or they keep a loser forever because selling would mean admitting a mistake, or giving up a sentimental attachment, like that mutual fund Grandpa passed along. Both moves are symptoms of loser’s fallacy.

A realistic attitude and an eye on the big picture are key to weathering losses. First, ask whether the investment is losing money, or just not making as much money as it once did. A fund that returns 25 percent for a year and then begins producing 10 percent isn’t a loser; it’s just performing more moderately.

Next, focus on the health and diversification of your entire portfolio, not on the fate of any one investment. “You should be diversified into enough different asset classes that it doesn’t matter if one is losing money,” Winbush says. Over the long term, that diversification will help you make more money than any one investment loses.

“Instead of panicking over a single loss, make decisions based on your overall portfolio. Ask yourself: Are you making enough money to reach your financial goals?” suggests Thrivent Financial Consultant Joel Hermann of Green Bay, Wisconsin. You and your Thrivent Financial representative should revisit your plan regularly and make any necessary changes.

Ingrid Case is a Minneapolis, Minnesota, freelance writer whose work has appeared in previous issues of Thrivent magazine.

Sweet Success

Like a lot of portfolios, the investments held by April and Fred Bornowski lost value when the market dropped in 2000. But the Bornowskis, Thrivent Financial for Lutherans members who live in Green Bay, Wisconsin, refused to panic.

Instead, they worked with their Thrivent Financial representative. “We sat down and talked, and decided to hedge our bets by diversifying,” says Fred Bornowski. “The formula Thrivent Financial recommended was what we went with.”

Before the market drop, the couple’s portfolio contained mostly U.S. stocks, mainly held in mutual funds. After they diversified, the new portfolio still contained U.S. equity mutual funds, but it also held bond funds, money market funds, international stock mutual funds and some U.S. small-capitalization funds, which the Bornowskis hadn’t purchased before.

All in all, Fred says, the new mix has done well. “I think it’s leveled out the market for us,” he says. “There are still ups and downs, but we remember that we’re not in it for a couple of months—we’re it in for the long haul.”

—I.C.

What Are Your Fallacies?

Which financial fallacies are threatening your portfolio? Take our quiz to find out. Match the behavior in left column to the fallacy in right column.

ANSWERS: 1. B; 2. D; 3. A; 4. C.

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