Soon after news broke that my home state of Ohio would shut schools for at least three weeks, I saw my neighbor returning from a Costco Wholesale Corp. (Nasdaq: COST) run to stock up for his family.
He mentioned that water was still available for purchase.
But then a look of disappointment crossed his face … the one item he really wanted was out of stock.
No toilet paper.
Why is everyone across the U.S. stockpiling toilet paper? Human nature goes a long way toward explaining the situation.
According to psychologists, shopping can play into our need for control over a situation. But there’s also a social aspect to it.
When we don’t know what to do, we look to others for guidance. Somewhere along the way, images of shopping carts full of toilet paper ignited a frenzy.
And this is where parallels can be drawn to the financial markets and investors.
Fear and Greed Drive the Market More Than Fundamentals
Most college investment coursework focuses on how investing should work.
You learn about theoretical models used to price assets such as stocks. The academics behind these models like to make assumptions.
One assumption of a popular model is that investors pay no taxes. Seriously!
But one thing none of these models incorporate is our own internal “fight or flight” tendencies … the tendencies driving the panic on Main Street and Wall Street right now.
Looking back, that’s why I should have prepared for my investing career by studying psychology instead.
There’s actually a growing field dedicated to studying investor psychology called behavioral finance.
In fact, researchers have already discovered and classified several key biases that impact investor behavior.
Here are some of my favorites:
- Herd mentality: Investors follow what others are doing. (Toilet paper shortage, anyone?)
- Confirmation: Only focusing on information that reinforces your views.
- Overconfidence: Letting your ego take control.
- Hindsight: Believing a past event was more predictable than it actually was.
Unfortunately, most of these biases are responsible for delivering losses instead of profits. We end up doing the wrong thing at the wrong time.
So do yourself a favor. Instead of being a reflexive investor who trades by the seat of their pants, become a reflective investor … one who is aware of your own biases and how they impact your decisions.
That will not only help you make better investment decisions, but perhaps put your mind at ease about the national toilet paper shortage and supply.
Research Analyst, The Bauman Letter