Every smart investment, whether we’re talking real estate or exchange-traded funds, starts with a good decision.
I’ve already talked about how risk aversion can influence decision-making, but it’s only one piece of the puzzle. One very small, if very important, piece. Which is why today I want to look a little bit more at how we, as real estate investors, can use good decision-making skills to optimize our investments.
So, if the foundation of every smart investment is a good decision, what’s makes a good decision?
Most people will say a good decision is defined by its outcome. Actually, we’ve all done this at one point or another. We’ll look at an investment we made—a gamble, to use the parlance—and if there’s a solid return on investment we’ll pat ourselves on the back. Good decision, right?
Evaluating a decision based on outcome is extremely problematic. For one, it relies entirely on hindsight. In other words, it assumes that we can’t determine whether a decision was good or not until the results have come in. Until after the fact. This assumption is false.
Good decisions exist independently of outcomes. Sounds weird, I know, but it’s true. They’re arrived at when someone attempts to be objective. I say “attempts” because none of us, no matter how hard we might try, can ever truly be objective. There are just too many variables that exist, in our minds and outside it that we can’t account for.
But we can be rational. So we can say that every good decision is, at its heart, rationally motivated.
Surprisingly, most investors don’t act rationally.
Using Your Head to get Ahead
Too many people invest with their gut. Or even worse, their heart. A 2010 study by Michael Seiler and researchers from Johns Hopkins University found that real estate agent attractiveness played a role in influencing buyer perceptions. Shocking, I know. Talk about bad decision-making. And this is just the tip of the iceberg.
To be sure that your decision to invest in a certain property is a good one; that is, rationally motivated, here are some of the common psychological hurdles investors need to overcome.
Nobody wants to be a loser.
Humans react very strongly to loss. More strongly, in fact, than we do to proportionate gains. And this sensitivity drives us to make extremely poor decisions.
Loss aversion is what prevents the risk averse from making a gamble, even if it’s a sound one.
It also creates a precondition in the mind of the investor. Those who experience loss aversion have to realize a final state of wealth that exceeds their initial investment. So much, in fact, that they’re willing to rush sell an investment if it helps them realize immediate gains, instead of holding onto it over the long term and realizing even more gains.
Winning isn’t the same thing as not losing. If you want to make a winning investment, it’s important to identify whether or not you’re loss averse. If you are, remember: there’ll always be ups and downs in the market, but in the long term you’ll come out ahead.
The Gambler’s Fallacy
At one point or another, we’ve all been guilty of the gambler’s fallacy. It’s a pretty common misconception—that, in a situation of random chance, the outcome can be influenced by preceding outcomes.
For example: I flip a coin ten times. It comes up tails every. single. time. So I believe there’s an increased probability that on flip eleven, it’ll come up heads.
Not so. On each flip, the probability of getting heads, or tails, is 50%. And that doesn’t change, no matter how many coin flips you do.
Gambler’s fallacy is a huge pitfall. It encourages the misperception that an investment opportunity is somehow contingent upon previous investment outcomes. It creates a massive blind spot for the investor. Always be sure to evaluate an investment on its own terms.
Which leads us to…
Information empowers investors to make better decisions. Choice is important, too. Choice means more opportunities. All good stuff, right?
For someone suffering from analysis paralysis, more information and variety can mean too much of a good thing. Analysis paralysis is when an individual almost compulsively collects and analyzes market data—but gets lost in the details. So much so, that they become uncertain about the correct course of action.
Hesitating to pull the trigger on an investment when it’s appropriate can lead to missed opportunities.
Every investment you make is a gamble. There’s always some element of risk involved. When information ceases to empower you, and instead prevents you from making the right decision, you might have analysis paralysis.
My advice? Talk to someone in the know. Seriously. It’s so easy to get caught up in your own head. Sometimes gaining someone else’s perspective can give you that extra push you need. If you want, get in touch with me. I’m be happy to help.
Next time you’re looking at making an investment, make sure your decision is rationally motivated. If it is then feel free to pat yourself on the back because you’ve made a good decision.