Investing without Wall Street: The Five Essentials of Financial Freedom

CHAPTER 14

The Psychology of Investing

Understanding the psychology of investing is on my “what's important” list. As Yogi Berra once put it, “Ninety-five percent of this game is 50 percent mental.”

Your mental attitude toward investing is critical. Entire books have been written about its importance. Academic studies exploring the subject are now popular. So let me touch on some of the psycho-logical topics that are relevant to your investing success.

Anchoring

Anchoring is a universal psychological phenomenon. We tend to base estimates and decisions on known anchors or familiar positions, with an adjustment relative to this starting point. Anchoring influences the way we intuitively assess probabilities. That's because we are better at relative thinking than absolute thinking.

Here are some familiar noninvestment examples of anchoring:

• Discounts off a list price. Stores routinely advertise 20 percent off, 50 percent off, and so on, not the absolute sale price.
• If the price of a house has been reduced, that's highlighted because many buyers may believe that makes it a good deal.
• “Used cars for less” or “dress for less.” Now, that's anchoring at its best.

In all these cases, we are influenced by the anchor. We don't really know if anyone ever bought at the list price. We don't know if the discount price is a good value just because the asking price of a house has been reduced.

Anchoring has a number of applications to investing.

• Investors will tend to hang on to losing investments ...