KEY POINTS:
Economic students are taught that financial markets are all about numbers and cold hard logic, but a growing pool of evidence suggests few of us make investment decisions without some kind of emotional involvement.
Goldman Sachs JBWere director Mark Warminger said as an investment manager he had to
be acutely aware of psychological influences on investment decisions but by understanding how they worked they could be overcome.
Warminger told professional investors at Friday's Fundsource managed funds conference that stupidity and irrationality were nothing new and scientists such as Albert Einstein and Isaac Newton had remarked on them in their own times.
"Economic literature assumes people act in a logical way. As human beings we like to think we are more intelligent. But when asked, 82 per cent of people say they are in the top 30 per cent of drivers. And when people say they are 90 per cent sure, studies show they are right about 70 per cent of the time."
Warminger said overconfidence often led investors to make more trades as it helped to make them feel more in control, but in reality it could end up costing them a lot in commission and broker fees.
Another area where investors fell down was in their selective memory.
"We don't like to remember our bad mistakes."
So a bad investment decision can be glossed over or explained away as being caused by the market, stopping us from learning not to make the same mistake again.
Warminger said the same situation could also happen for those who did not have enough conviction in their choices as they excused poor performance when buying the investment - just on the likelihood that it will be giving ourselves a scapegoat.
Humans were also very susceptible to regret, making it hard to distinguish between a bad decision - where an investor should sell out as soon as possible - and a bad outcome, where a company performs badly for a specific reason and could turn around its performance.
"We have an unwillingness to admit defeat and ride our losses in the hope that they will turn around."
Other issues such as our emotional attachment to something we pay for over something given as a gift and placing too much emphasis on recent events also caused problems.
Although Warminger said human beings were unlikely to change their ways, being better aware of our shortfalls can make us better investors.
