Five tips to avoid psychological investing mistakes.

I haven’t written much lately about behavioural finance – the way in which human psychology makes successful investing more difficult – but a terrific sentence summing up the importance of the topic in a blog post by U.K.-based fund manager and author Joe Wiggins provided a good excuse to revisit the theme. Mr. Wiggins wrote: “The central issue that behavioural finance faces is that – at its core – it is asking investors to stop doing things they inherently and instinctively want to do.”

Mr. Wiggins began with the example of an investor selling a fund with poor recent returns. This might feel satisfying in the moment but extremes in negative sentiment often represent a bottom in investments, and that person selling might be locking in a loss when a recovery is imminent.

The human tendency to feed our egos can also get in the way of portfolio returns. The belief that we are smarter than others leads to strategies with proven low probabilities of success, like market timing. Ego can also lead to getting emotionally attached to an investment idea and refusing to admit it hasn’t worked.

Mr. Wiggins makes the important point that the finance industry encourages our worst tendencies. Finance theory shows that the more transactions an investor makes, the more likely underperformance becomes. Yet financial professionals often encourage transactions because they generate fees. He writes: “Lots of value accrues to turnover, stories, short termism and irrelevant comparisons. When I say value, I mean fees – not performance.”

The author offers five rules of thumb to avoid psychological hurdles to investing.

The first is to avoid behaviours that provide immediate satisfaction. The second is to accept that we are not smarter than the market.

The third tip is to avoid looking at what other investors are doing; the fourth is to accept that markets are extraordinarily complex and, in the end, unpredictable over shorter time frames. The fifth and final rule is to ignore most of what has grabbed your attention in any given day when making investment decisions. This is similar to venture capitalist Morgan Housel’s advice to avoid all news that is unlikely to be relevant three months in the future.

Mr. Wiggins’ column is a useful reminder that our brains did not evolve to invest in markets and in many many ways human psychology is actively working against portfolio returns. When making portfolio decisions, investors must always question whether they are doing what feels right, or what is right based on market history.