Being undermined by our human natureWe are not the homogenous, rational participants envisaged by the creators of the efficient markets hypothesis.
Successful investment requires cool rational thought at all times. Sadly, the human brain is badly equipped for this. We overreact to fear because the amygdala, a part of the brain that controls our responses, has only evolved a little from the period when threats came in the shape of sabre toothed tigers. The consequences of a market decline are considerably less serious but our brains don’t really understand that.
We also tend to be overconfident about our level of knowledge and the quality of information we possess. That can lead to greed taking over and affecting our judgement. If things then go badly we suffer remorse, which also disrupts behaviour.
All humans have these failings but the very best investors, like Warren Buffett, have found ways to control their emotions to minimise errors.
EQ tip: Don’t panic when the markets enter a period of turbulence and make sure you’re happy with the characteristics of your portfolio