Humans are not always rational.
We like to think that we are, but the truth is that our decision-making processes are often riddled with cognitive biases: attachments, traps, and emotional turbulence.
In Daniel Kahneman’s 2011 book “Thinking, Fast and Slow”, the Israeli-American psychologist explores two modes of thought: fast and emotional versus slow and logical. On one hand, our intuitive feelings serve a survival purpose: alerting us that something doesn’t seem right in our environment, prompting us to find safety as soon as we notice danger. On the other hand, thinking in a more deliberate manner serves many practical purposes that can benefit us greatly in both life and business.
Whether you are a new or experienced investor, it is always a good idea to revisit the psychology of investing.
Disclaimer: This article is for informational purposes only and is not meant to provide readers with investing advice.
Overconfidence Can Lead To Unreasonable Optimism
We’ve all been overly eager or excited about something at some point in our lives. But being too excited can sometimes backfire on us. We are more likely to attribute positive outcomes to our own merits while attributing negative outcomes to external factors. We may overestimate our abilities and believe in certain investments more than we should, leading to poor diversification. Graduates from the University of California found that traders who were less active had a higher annual portfolio return than those who were more active.
Loss Aversion Can Lead To Negativity Bias
The most famous rule on Wall Street is to “cut your losses short and let your winners run.” However, humans have the tendency to experience more pain with losses than joy with gains in response to equivalent amounts. Humans are more likely to make mistakes under severe emotional pain. This can lead to investors making the mistake of selling low and buying high because of our emotional attachment to losses.
Mitigating Risk With Portfolio Diversification
There is, fortunately, a way for smart investors to strategically allocate their assets so as to avoid overconfidence and loss aversion. Irrational investing can be avoided with portfolio diversification.
Diversification involves combining various types and classes of investments within a portfolio, so as to avoid “putting all of your eggs in one basket.” On average, a portfolio that contains different kinds of investments will have better risk management than any single investment alone.
Real estate is considered to offer high diversification potential within a portfolio. While it isn’t free from volatility or risk, real estate investments—especially real estate blockchain investments—have a low correlation to market volatility, especially over the long run.
Some investors may find it financially difficult to buy into traditional forms of real estate investing, as for instance, buying a home requires a down payment and mortgage approval. However, instead of buying a property in its entirety, investors can now buy shares of a single property through fractional real estate investing. Online marketplaces like Real T make real estate investments accessible with some property tokens listed for under $100 each. The benefits of blockchain technology including immutability, security, and decentralization extend to real estate blockchain investing.