Why Smart People Make Big Investing Mistakes
Reflections #13
Welcome to this week’s Reflections. Even the smartest minds aren’t immune to errors when it comes to investing. Our brains are wired with biases and cognitive shortcuts that can lead to irrational decisions—even for those with extensive knowledge and experience. This week, we’re diving into why smart people often make big investing mistakes and how to avoid them.
Smart people tend to think they’re immune to the following pitfalls, but intelligence often amplifies certain biases rather than eliminating them. Understanding why these mistakes happen is the first step toward making better decisions.
1. Mental Accounting: All Money Is Not the Same
The parable of the groom on his honeymoon in Vegas illustrates mental accounting perfectly. Starting with just $5, he bet his winnings repeatedly until he amassed millions—only to lose it all in one final bet. His reaction? “Not bad, I lost $5.”
This mindset treats gains as “house money,” making losses feel less painful. In reality, every dollar is the same. Failing to see this can lead to reckless decisions and overconfidence with newfound wealth.
2. Loss Aversion and the Disposition Effect
Smart investors fall prey to loss aversion, where the pain of losing feels worse than the pleasure of gaining. This often manifests as the disposition effect—the tendency to hold losing investments too long while selling winners too quickly.
Why does this happen? Losses feel like failures, so we delay recognising them. Meanwhile, locking in gains offers quick gratification. Successful investing requires flipping this tendency: let winners run and cut losses early.
3. The Sunk Cost Fallacy: Throwing Good Money After Bad
One of the most common errors is the sunk cost fallacy—sticking with a bad investment because you’ve “already put so much into it.” Smart people rationalise this behaviour by focusing on the past rather than the future.
Good decisions ignore sunk costs. The value of your current investment lies in its future potential, not in what you’ve already spent.
4. Overconfidence: Knowing Too Much (or Too Little)
Ironically, intelligence can fuel overconfidence. Smart people often believe their knowledge shields them from mistakes. In reality, overconfidence blinds them to risks, encourages excessive trading, and makes them vulnerable to unpredictable outcomes.
Being aware of this bias and staying humble can prevent costly errors. Remember: markets don’t care how smart you are.
5. Anchoring Bias: Stuck on the Wrong Number
Another trap is anchoring bias, where decisions are overly influenced by an initial figure or reference point. For example, investors might fixate on a stock’s past high price, refusing to sell until it returns there—even if its prospects have deteriorated.
Avoid anchoring by assessing investments based on current and future value, not historical prices.
6. Availability Bias: Misjudging Probability
People often assess risks based on how easily examples come to mind—a mental shortcut known as availability bias. For instance, vivid news stories about market crashes or improbable events, like shark attacks, can skew perceptions of actual probabilities.
Smart investors rely on data and long-term trends, not anecdotal evidence, to guide decisions.
7. The Trade-Off Trap: Too Many Choices
When faced with multiple options, even irrelevant ones, decision-making becomes harder—a phenomenon known as trade-off contrast. Investors might choose suboptimal options simply because they’re overwhelmed by alternatives.
Simplify choices by focusing on your goals and filtering out noise.
8. Recency and Hindsight Bias: The Weight of Recent Events
Recent events often overshadow historical context due to recency bias. Similarly, hindsight bias leads us to believe past outcomes were predictable, impairing our ability to learn from mistakes.
Avoid these traps by evaluating events in the broader context and accepting that some outcomes are unpredictable.
9. Survivorship Bias: Ignoring Failures
Focusing only on success stories can distort reality—a classic case of survivorship bias. For example, studying only profitable companies without considering those that failed skews conclusions and creates unrealistic expectations.
To make sound decisions, examine all outcomes, including failures.
Principles to Avoid Money Mistakes
All Money is Equal: Treat every dollar the same, regardless of its source.
Losses Hurt More: Recognise and plan for your aversion to loss.
Focus on the Future: Don’t let sunk costs dictate decisions.
Stay Humble: Overconfidence leads to errors.
Simplify Decisions: Too many choices create confusion.
Don’t Chase Noise: Ignore irrelevant or emotionally charged information.
Think Long-Term: Avoid being swayed by short-term trends or recent events.
Smart people make big investing mistakes because intelligence doesn’t shield us from biases. Recognising these mental traps is the first step toward avoiding them. By staying disciplined, questioning assumptions, and focusing on long-term goals, you can make better decisions and avoid costly errors.
ICYMI
Our investing philosophy:
If you like our work and you’re interested in the types of companies we invest in, check out our most recent portfolio update here:
We hope you enjoyed this post. If you found it valuable, feel free to share it, and stay tuned for our next edition!
Enjoy the rest of your week.
The S.C. Team
Disclaimer: The content provided in this newsletter is for informational purposes only and does not constitute financial, investment, or other professional advice. The opinions expressed here are those of the author and do not necessarily reflect the views of Schwar Capital. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The author may or may not hold positions in the stocks or other financial instruments mentioned. Always do your own research or consult with a qualified financial advisor before making any investment decisions.