3.4. Sidestepping Pitfalls in Investor Psychology

In theory, investors are rational people, but you're an investor and you know you're not completely rational all the time. When you're outside your comfort zone, as many people are when they invest, you may act irrationally. It turns out that some of your bad habits are hardwired into your brain—after all, those habits helped early humans survive in the wild (long before they started investing). For example, early humans who were part of a community survived, while individualists often became someone's lunch.

Even today, people experience pain when they go their own way. The result is herd behavior, that is, doing what everyone else is doing. For investors, herd behavior often means buying because everyone else is. Unfortunately, by the time you buy, the people who bought before you have inflated the investment's price, so you may end up buying at a higher price than the investment is worth. If you sell after everyone else has sold, you sell at a price that's often below the true value of the investment.