When asked what characterizes a good investment, people put emphasis on conducting thorough due diligence by analyzing the current trends of the target industry and ensuring that the company operations are clean before investing. Additionally, emotional discipline is widely recognized as a critical attribute, enabling investors to avoid impulsive decisions fueled by greed or fear. A disciplined investor should conduct thorough research on the appropriate strategy so that he may make a sound decision. A good investment decision should also be flexible to the changing times of the market due to new information.
Yet, despite having access to real-time data on the internet and having access to risk management tools such as Value at Risk (VaR), which quantifies the potential loss of an investment over a specific time period with a given probability, well- seasoned investors still find themselves falling for the same behavioral and emotional traps that drive them toward making high-risk investments. There are several factors that can explain this behavior among experienced investors, among them being arrogance. Past successes often make experienced investors overconfident in their capability in predicting market movements. This overconfidence may eventually result in them taking excessive risks since they are under the assumption that they have the outcomes under control than they actually do. For example, an investor may decide to dismiss advice from renowned experts in the industry since they rely on their past successes to make decisions on which strategy they should take. Their overconfidence, therefore, can push them into high risk strategies such as investing in a single asset instead of diversifying their investments. It is therefore advisable for investors to be flexible in their investment strategies despite their successes in the past.
A second factor is the high-risk appetite fueled by the thrill of uncertainty. Some experienced investors always thrive to get that adrenaline rush that comes in pursuing high risk ventures instead of performing a thorough research on the most appropriate investment strategy that would prove beneficial to them. This can be easily explained through high stakes options trading where a trader repeatedly trades with short-term options with a massive downside risk, preferring the thrill of potential large gains over a stable and long-term growth. Therefore, it is advisable that investors should establish clear risk limits and avoid making emotional decisions.
Another key influence is the fear of missing out (FOMO). When investors reap handsomely from their risky investment strategies, other investors feel compelled to follow their path so that they may also gain the same benefits. However, this is not advisable because a smart investor should do proper research on an investment product before committing an investment. During the rise of cryptocurrency in the late 2000s and early 2010s, many investors dived into bitcoin and other alternative products without performing the necessary research to identify the nature of this product since other investors were already reaping hugely. However, due to its volatile nature many people suffered great losses since its value kept on fluctuating over time.
Risk is inherent, but succumbing to external pressures or behavioral biases can amplify its downsides. By recognizing these pitfalls, overconfidence, thrill-seeking and fear of missing out, investors can adopt structured risk management practices to enhance decision making. Thorough due diligence and a commitment to rationality remain essential to mitigating the adverse effects of poor investment choices.
