Psychology plays a crucial role in investing.

Emotions that affect investing include fear and greed, but emotions are much more diverse and can significantly impact outcomes.

An investor's psychological state can affect the performance of their investment portfolio because investment decisions are directly related to emotions.

Build a portfolio that aligns with your investment goals; you can only benefit by comparing your "personal profile" with your investment strategy.

Investor psychology and investment outcomes

Many market commentators often throw around concepts like "fear and greed," and their role in individual and overall market behavior. While fear and greed play a role in both individual and mass behavior, they are part of a broader set of attitudes and emotions that influence our investment decisions.

I am an investor with growth/value stocks, high-dividend stocks, and traditional dividend stocks. Although I did not first consider psychological factors before making investments, I do try to understand how specific traits and tendencies will affect my investment decisions. Whether this awareness helps my investment decisions is, of course, difficult to measure.

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The role of emotions in investing: Graham, Newton, and investor cargo

Psychology, emotions, and irrationality play a key role in investing. We assume we are rational beings, but the content of this blog suggests otherwise.The widely accepted economic and financial theory posits that individuals are well-informed and make decisions in unison. It regards investors as "rational." It is evident, however, that humans do not act rationally. In fact, humans often engage in counterproductive, systematic irrational behavior.

As children, we protect the world and our self-perception through a protective lens. Growing up, the process of maturing includes recognizing the true "size" of the world.

As many observers have noted, the emotional makeup of investors is more crucial to investment success than intelligence or "book knowledge." This is a simple statement, but I suspect that most investors overlook its implications when making investment decisions.

Astute investors are those who are adept at harnessing their emotions. For instance, the great investor Benjamin Graham defined intelligent investing in his timeless book "The Intelligent Investor" as the application of intelligence that "has more characteristics than human nature."

The story of the distinguished scientist Isaac Newton investing capital speculatively in the South Seas Company provides a counterexample to this definition. It was a great growth story of the era. Sadly, three hundred years ago, the South Sea turned out to be a failed proposition. The ability to define gravity and a series of equally remarkable achievements did not make Newton a good investor.

We must undertake investments that carry our fundamental experiences, psychological traits, habits, and tendencies. Some might call it "baggage," but I prefer the term "cargo."

The best investors typically remain calm and patient, capable of setting strategic goals and adjusting as needed. They do not panic. They may also possess good self-esteem and learn from their mistakes.

Psychological behaviors that may impair investment returns

Let's examine some known emotional characteristics and behaviors that directly affect investors' choices and provide a picture of how emotions might intervene in investments. Any of these behaviors can be considered an expression of investment biases.

Morningstar is the primary source for this section, and it is an excellent channel for conducting investment research.Compared to reality, overconfidence is an exaggerated belief in one's own abilities. In investing, overconfidence can lead to excessive trading. Investors replace confidence in actual knowledge with "confidence," which in turn leads to mistakes, additional commissions, and related costs.

Self-attribution is another form of investment bias. Those who exhibit this trait attribute positive, successful investment outcomes to themselves, while attributing poor results to external factors. While providing self-comfort, self-attribution may damage returns over time.

Selective memory retains certain memories and expels others from our consciousness. It can prompt us to remember our good decisions and forget the bad ones. Selective memory distorts investors' rearview perspectives and encourages overconfidence.

Self-handicapping refers to the term where investors create initial excuses when they make investment mistakes. An example is "The stock didn't do well; I must not have done the right research."

This is another emotional habit that gives investors too much power, distorting buy and sell decisions.

Herd mentality is following the crowd. This can lead to too casual research or purchasing stocks that rely on reputation. Chasing the herd can also cause investors to miss out on solid stocks that are lesser-known but stable in the investment field.

All of these behaviors are natural expressions of human psychology. No one is immune to breaking reliable investment strategies and practices. Combined, they are return limiters. Moreover, investors who become engrossed in one or more of these habits are likely to repeat their mistakes, further exacerbating the damage.

Basic Investor Psychological Profile (IPP)

Each investor is unique and has distinct emotional preferences and (hopefully) strategies aimed at meeting their strategic investment needs. This interaction is rarely discussed in conversations about investing. However, it is meaningful that investment strategies should not only meet the requirements of economic parameters but also align with the investor's personality.

Here are some sample investor profiles. These are not "scientific" profiles but are proposed to understand how different personality types match with specific profile bags. The implication is that this comparison of investor psychological conditions and portfolios is a useful step that every investor can take.Aggressive Investor

This investor wants results and is rigid and impatient. He may be more inclined towards certain psychological behaviors that we describe than other profiles. This configuration is ill-suited for long-term strategies characterized by buying stocks and holding them for the long term.

The aggressive investor is a risky investor unless he has a very long time horizon and can restrain impulsive buying and selling. Alternatively, if he has sufficient self-discipline, he can limit the percentage of his portfolio that his securities represent. Almost by definition, this personality is more suited to trading than investing.

Flexible Investor

This investor is neither inherently aggressive nor defensive. Instead, he is pragmatic, open, and adaptable. The flexible investor is also naturally someone who avoids the syndromes of overconfidence or self-attribution, which can lead to poor performance. Pragmatic individuals seem to have an innate ability to suppress such impulses.

This profile may be best suited for a balanced portfolio that mixes risk and reward. For safety, we can intuitively see a portfolio that maintains a balance between growth and value, with stable income (dividends), as well as bonds and cash. This is likely to produce relatively consistent results without fundamental changes in position or allocation.

Defensive (Conservative) Investor

This investor is naturally cautious, even timid. Risk frightens him, and safety reassures him. Even a young defensive investor may avoid portfolios with too much exposure to growth or speculative issues. In fact, having a high proportion of stocks in the portfolio may cause unease.

The defensive investor will seek a portfolio that offers the greatest safety and the least risk. For this scenario, a meaningful portfolio would consist of a few stocks with most of the value or blue-chip stocks, along with most bonds and other fixed instruments. Starting with a more aggressive investment palette may prompt the cautious investor to modify their holdings in sync with their emotional constitution.

Anxious Investor

(Note: The original text ends abruptly with "Anxious Investor" and does not provide further details about this profile. If you have more information or context about this type of investor, please provide it so I can continue the translation accordingly.)The anxious investor represents another scenario. An eager investor may be aggressive, pragmatic, or cautious, but is simply unable to overcome the habit of anxiety. This anxiety almost inevitably leads to poor investment decisions, excessive selling, and frequent changes in portfolio strategy. The anxious investor is truly not suited to entering the market unless he learns to alleviate the anxiety that causes destructive investment behavior. Market pressures can make confident individuals feel nervous and may cause real psychological harm to those with long-term anxiety.

Traders

Traders enjoy the hustle and bustle of trading. They are looking for short-term gains and believe that short-term profits can be achieved as long as they have the right system or market/investment knowledge. Traders are usually clever and may be very intelligent, being a good student. Despite these characteristics, they may become overconfident due to them. Some traders convince themselves that they are the real investors when they are not. Whether this leads to excessive confidence or not, they are not investors in reality. (I include them here because many traders are active in the market.)

Conclusion

Investing is not an empirical science. It may even be a combination of art and science. Fundamental and technical analysis are certainly important, as is investor psychology. Although investors cannot control the trends on the charts or basic factors such as the price-to-earnings ratio or earnings per share, they can certainly assess their own psychology.

The most important aspect of investing remains the proper construction of the investment portfolio. It is worth considering whether there is a "discrepancy" between the portfolio and personal psychology. None of us is complete or perfect, and we will continue to learn throughout our lives. Your investment portfolio may thank you for it.

Successful investing is for everyone.