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The way to make money in investments is simple, right? Buy low, sell high. Seems like such a straightforward concept.

If this is true then why do so many investors do the exact opposite? It’s been said that stocks seem to be about the only thing in the world people don’t want to buy when they’re on sale. A powerful example of this is found by evaluating the performance of the stock market versus that of the “average investor.” According to a Dalbar Inc. study, over the last 20 years (1998-2017) the S&P 500 stock index had an average annual return of 7.2 percent. By contrast, the average investor generated a meager 2.6 percent average annual return. To put some numbers around that, a $10,000 investment in the S&P 500 index would’ve been worth $40,169 in 20 years whereas the average investor’s $10,000 would have only grown to $16,709.

It turns out that there are some really good reasons for this poor performance by the average investor. We humans come hard-wired with some innate biases that work against us when we don our investor hat. Over the last few decades, a field of study called “behavioral finance” or “behavioral economics” has emerged to help explain why we make the decisions (and often mistakes) that we do when it comes to our money. Some of the professors who pioneered these studies have won a few Nobel prizes, so it’s probably worth taking note.

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