Investment Risk Management: Inevitable Brain Mistakes
Introduction
Investment risk management is all about managing the uncertain world of finance and safeguarding your money from possible disasters. It’s an important consideration for anybody trying to increase their wealth while looking for potential problems. Understanding how to handle these risks can help you achieve your financial goals while having peace of mind.
Cognitive illusions are prevalent around the globe and impact millions of people every day. One way cognitive illusions affect individuals is through social interactions. Someone might base their actions on familiarity with the circumstances, which can lead to awkward interactions and off-timing comments. Another example of how cognitive illusions affect people is through self-assessments. Illusions such as the Dunning-Kruger effect affect individuals by overestimating their competence, leading to harmful decision-making or plain incompetence. An example of the Dunning-Kruger effect would be with a beginner chef making their first few dishes. They may believe they are an excellent chef and on par with gourmet chefs, however, their lack of knowledge of advanced cooking techniques, flavor combinations, and culinary theory leads them to overestimate their capabilities. Finally, an example of how cognitive illusions affect individuals is through memorization and learning. Cognitive illusions may prevent someone from acquiring new information. Also, they may cause someone to remember things that never happened, which can contradict new information and make learning new things more difficult.
What Are Cognitive Illusions?
Cognitive illusions are mistakes made when recalling memories or judgments due to how the brain processes information and systematic errors that are made in decision-making.
What Is Investment Risk Management?
When identifying which investments to pursue, one undergoes the process of determining and analyzing the risks associated with the investments to mitigate losses and maximize profits.
Case Study: Cognitive Illusions While Identifying and Analyzing Investments
Cognitive illusions can also greatly affect deciding which investments are worth the risk. When finding a good investment, one identifies whether the risks are worth the benefits. Cognitive illusions can lead individuals to think a company performed better than it did, which could incline them more to invest when ultimately it would be considered a bad investment. A company could be on a decline, however, because of an individual good day, an investor could ignore the stock’s history and determine that it is worth investing in. Also, cognitive illusions can affect investment risk management by determining how the market is moving. Reading the market and identifying when the greatest profits are possible is a key skill of any investor. Cognitive illusions can lead one to overestimate their ability to read the market and make riskier decisions based on their assumptions of how the market will move. Ultimately, this leads to more losses than wins as the market is unpredictable, but it still can be understood enough to generate solid, smart profits. Finally, a way in which cognitive illusions affect investment risk management is through misinterpreting market signals. Cognitive illusions can cause an individual to ignore or neglect signals in the market, which can cause someone to invest or remove investments at inappropriate times. Although the market could crash unpredictably, certain signals and patterns that signify future losses or boosts could be read to generate profits.
Cognitive illusions affect millions of people everywhere, so it is no surprise they influence New Yorkers’ ability to determine the right stocks to invest in. An environmental factor regarding New York that plays into cognitive illusions is it is fast-paced. In New York, deals can be missed within seconds, decisions can depend on the minute, and life-changing moments can happen every hour. With everything happening so fast, making mistakes and incorrect judgments are bound to happen. Making a bad investment decision with a lack of time can happen easily. When everything around someone happens so fast, cognitive illusions are inevitable. Being under stressful conditions can lead the brain to make more impulsive decisions, in New York, being in a constantly stressful mind, it is hard to choose the correct impulse repeatedly. Investors require a lot of research to feel confident about what they are investing in. However, simultaneously, time is not in favor of investors, especially those who day-trade. Making quick decisions is crucial for day traders, but quick decisions can also allow useful information to slip the mind, leading to a devastating defeat. Forgetting about a stock’s history and patterns simply because of unexpected growth can lead to misjudgment. It is important to recognize an opportunity to jump on, but it is equally important to evaluate risks and potential issues with the investment.
Stratagies To Overcome Cognitive Illusions
How To Avoid Cognitive Illusions In Everyday Life:
- Question your initial assumptions and reactions
- Avoid rushing to judgments or decisions when possible
- Recognize when emotions might cloud your judgment
How To Avoid Cognitive Illusions When Identifying And Analyzing Investments:
- Make investment decisions based on thorough research
- Don’t put all your eggs in one basket
- Periodically review your portfolio and investment decisions
What Do You Think?
How do your emotions and biases, like overconfidence or fear of loss, influence your investment decisions? Have you ever felt overly optimistic or pessimistic about an investment because of recent market news, and how did that affect your choices? Have you ever gone all in for something that you shouldn’t have?
Resources
https://www.lexioncapital.com/illusion-control-can-deceive-investor
https://www.buckinghamstrategicwealth.com/resources/investing/optical-illusions-in-investing
Podcast On Financial Literacy
From That’s That. Podcast