Gold is up nearly 20% this year as investors pile into the precious metal for safety amid geopolitical uncertainty and trade war woes. Rational investors are buying gold for good reason.
Many stock investors may be tripping over a psychological investing pitfall known as the Endowment Effect.
This is a proven cognitive bias in which investors overvalue the worth of stocks that they own, and thus hang onto equity positions perhaps longer than they should. Why? The mere fact of ownership creates a psychological bias that it is worth more.
As the U.S. stock market climbs to all-time highs driven in large part to the low interest rate environment fueled by the Federal Reserve, equity valuations remain toppy and stretched.
Some stock market investors may be caught up in a Pollyanna view of the stock market.
Researchers first identified the Endowment Effect through experiments conducted with ordinary coffee cups. Ownership of a cup of coffee triggered a response where people demanded substantially more to sell the cup than if they did not own it. How much? Once owned, sellers required about twice as much to sell the cup as they were willing to pay to acquire it.
The Endowment Effect essentially put blinders on investors and blocks the ability to consider financial events rationally.
How to overcome this mental investing trap
Here are three tips to help you beat back this sneaky psychological mind trick as you plan your investment strategy for 2020:
- Be open to new information about the stock market and the economy. The Endowment Effect reveals a strong tendency to stubbornly stick to the old investment strategy despite new and better information.
- Be objective. Consider potential negative factors. The Endowment Effect creates a tendency to focus on the positive factors (Pollyanna view) while disregarding potential negative or changing signals.
- Create an investing plan and stick to it. Long-term investors do best when you develop and implement a clear investment process. This includes a well-diversified portfolio to offset and mitigate equity market risk.
Rational investors bought gold with a vengeance in 2019. Goldman Sachs recently reiterated its $1,600 an ounce price target for gold. If you haven’t fully diversified your portfolio, consider new information and review current economic and political conditions from an objective standpoint.
Call Blanchard today at 1-800-880-4653 for a personalized portfolio review and individual diversification recommendations based on your long-term financial goals and risk tolerance levels.
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