5 Mental Mistakes that Trim Investment Profits

You know about behavioral economics and how it shows that many of us seem hardwired to make decisions about money that are bad for us. Contrary to what economists say, people aren’t rational and profit-maximizing. Here’s a good summary of the five most common mental or thinking traits that lead to bad decisions.

Recency effect. Investors often make the costly mistake of thinking what’s going on now will continue, and that somehow the present is a harbinger for the future. In investing, investors think companies performing poorly now will continue to struggle, Huber says. And the same error in thinking leads investors to think that companies that are doing well will keep doing well. Huber calls this faulty thinking “distorted ROE reversion.”

Such errors can be costly. This isn’t Huber’s example, but it’s a good one: Lululemon (LULU). The athletic apparel company was putting up huge revenue and profit growth. Investors assumed this would continue. These bets on Lululemon proved very costly … and wrong.