Logical Fallacies in Investing

Categories : Financial, News
July 17, 2020

A fallacy is defined by Wikipedia as “the use of invalid or otherwise faulty reasoning, or “wrong moves” in the construction of an argument.” When it comes to money and investing, there are no shortage of these pitfalls, and most of them are guilty of at least one at one point or another. I picked out some of the most common ones we see in our practice to discuss today in hopes that you can avoid them in the future.

  1. That stock/bond/ETF/Mutual Fund is too expensive: For some reason, people think that the price of a share of an investment is important. It is not. The only time this is true is when the price of a single share is higher than the total amount you have to invest (see Berkshire Hathaway). Other than that, it is 100% irrelevant. The price of a share is only important relative to other figures, like the total shares outstanding, earnings, book value, or a host of other metrics that are used to measure the financial performance of a company. The price of a share does not measure value. For example, in the last 3 months, if you bought 1 share of Tesla at $400, and it is now trading over $1000, you made over $600. In the same time frame, if you bought 10 shares of Exxon Mobile for $40 each, it is now trading at $47 and you made $70. Which was the better investment?
  2. I am diversified, I own SPY: Just because an ETF has 500 stocks does not make it diversified. Buying a single ETF that contains only large-cap US stocks diversifies you out of single-stock risk, but it does not diversify you out of market risk, which is when the whole market goes down at once (just look at March of this year for an example). Owning SPY is certainly less risky than owning a single stock, but you have only addressed part of the problem.
  3. That stock only ever goes up: This is very common. People look at a stock on a multi-year run and wish they had gotten in several years ago. However, they then justify getting in a lofty valuation because they know in their hearts that this stock only ever goes up. However, that stock usually starts in a downtrend right after they purchase it.
  4. I am just waiting to break even: Sometimes an investment is a dog, and you know it, but you hate the thought of taking a loss on it. Many people cannot stomach the thought of selling anything for a loss, so they hold on to their investment, hoping and praying that the turnaround is just around the corner. In the weeks, months, and years that follow, many other investments have increased in value, but the dog you held onto still has not. Therefore, even if the investment stays stable, the opportunity cost of staying in it was the lost gains on the other investment. You gotta know when to fold ‘em as the song goes.
  5. Analysis paralysis: Certain types of investors like to make sure that they are making the absolute right decision to buy at the absolute best time. They have spreadsheets, computer programs, complicated algorithms, and yet they are sitting in cash. This is a common problem with engineers and other detail-oriented professionals. They get so caught up trying to make the right decision that they cannot make a reasonable decision. The point of investing is to make money, not to be a perfect investor. Stop over-analyzing and if necessary, seek out the help you need to make decisions.

We have seen all these logical fallacies in our practice, and if you have fallen for any of them, do not worry, you are not alone. Some advisors describe their job as the guard that stands between their clients and making these mistakes. If you find yourself repeatedly making any of these mistakes and need help with your money, please do not hesitate to come and see us.