Skip to content

Investor's chief adversary often lies not in market trends or financial analysis, but in emotional responses.

Almost seven decades ago, Benjamin Graham, the originator of value investing, understood that an investor's biggest adversary was often themselves.

Investor's biggest adversary often lies within their own emotions.
Investor's biggest adversary often lies within their own emotions.

Michael Blümke, a portfolio manager at Ethenea, has recently discussed the economic outlook, emphasising the improbability of a recession and the delayed interest rate cuts. However, his recommendations regarding the prevention of bias in investment have gained particular attention.

Blümke's insights draw inspiration from Benjamin Graham, often referred to as the father of value investing. Over 70 years ago, Graham identified the greatest enemy of every investor as themselves. This remains relevant today, according to Blümke.

One of the most well-known cognitive biases that investors should be aware of is the confirmation bias. This cognitive bias refers to people selectively choosing and interpreting information in a way that confirms their existing beliefs. Confirmation bias can lead to poor decisions because all viewpoints are not weighed against each other. In the investment realm, this bias can be particularly dangerous, as investors may only seek studies and metrics that support their investment thesis and ignore contradictory factors.

To avoid such mistakes, Blümke recommends clear rules for investing, thorough documentation, and an objective investment strategy. He emphasises the importance of having an idea of position sizes, risk budgets, and diversification. Investors should not fall in love with investments and should consider other opinions besides their own.

Another emotional bias that investors should be aware of is loss aversion. Psychologists Daniel Kahneman and Amos Tversky found that people weigh losses more heavily than gains of the same magnitude in their prospect theory. This means that when faced with a potential loss of 100 euros, an investor feels regret much more strongly than joy at a 100 euro gain. As a result, investors tend to act risk-averse when realizing gains, doing so too early, and risk-seeking when realizing losses, letting them run too long.

To combat this bias, Blümke suggests that investors should consistently limit losses during difficult market periods, preferably according to a predefined rules system. This approach can help investors make more rational decisions and avoid the emotional swings that can lead to poor investment choices.

In conclusion, understanding and managing cognitive biases is crucial for successful investing. By following clear rules, maintaining thorough documentation, and adopting an objective investment strategy, investors can make more informed decisions and potentially increase their returns.

Read also: