Mutual Fund Investment Mistake - 6: Bye, Bye Over-Optimism Performance

We are usually wildly over-optimistic when it comes to New Year`s resolutions, weight loss goals and investment targets. So why do we keep making the same mistake?

If you have been investing money, making some of it and also losing most of it, then maybe you are a victim of over-optimism.

The most probable reason why so many investment plans have an unhappy ending is not only that people foul up along the way – by avoiding to get out of a fund either because you hope it will rise further or because you are losing money on it and want to avert losses. It is also because they never stood much of a chance in the first place. Their hopes were too high.

When it comes to our investment decisions, we seem to put the chances of good things coming our way above the actual statistical likelihood. However, we consider the odds of bad things befalling us to be pretty remote, don’t we? Hence, in the ideal world in our minds, lay-offs and bankruptcy happen to other people; favourable market conditions and rocket-fuelled growth rates are supposedly considered to be our inheritance. Alas! Where’s the reality?

Investments are often subject to psychological errors, of which ignorance and over-optimism are deep rooted. Bid farewell to these investment mistakes and say hello to sensible investing. Optimism is good, but over-optimism is definitely a self-kill.

Over-optimism isn`t necessarily a bad thing. It helps drive business investment and economic activity. Moreover, if you did not have a bias towards optimism, you probably would not have clambered out of bed this morning and pushed your way through the rush hour crowd to another day back at work. So, yes, all said and done, false hopes help but the problem starts up when you extend this optimism to the goals you set for yourself, especially your financial goals.

Over estimating the likelihood of positive trends and under-estimating the likelihood of negative trends in the stock market is over-optimism in investment. You must get rid of this behaviour if you seek investment success. Your money will not grow with this magical thinking of optimism. You have to be grounded to take sound investment decisions.

So, how do you stay grounded? Well, it is quite simple.

i) Do not look at the yearly results/rankings of a Fund . Instead, focus on the four or five year averages. A long-term consistent performance is more reliable than a short-lived success.

ii) Do not look at a Fund that does extraordinary things to get extraordinary results. Simplicity, honesty and transparency too can deliver outstanding results.

Moreover, in order to avoid repeating this mistake, consider the way you review what you have done. One reason for repeating over-optimism is that we shape all our misses and hits into an account that shows up not how badly we`ve performed, but how close we came to doing well. Hence, review well!