The Impact of Investor Psychology and Behavioral Biases on Long-Term Performance and Value Investors' Response Strategies

Investor psychological biases are the “invisible killers” of long-term investment performance. According to behavioral finance research, multiple cognitive biases systematically damage investment returns:

• Investors’ pain from losses is about 2-2.5 times the pleasure from equivalent gains
• Leads to asymmetric behavior of “taking profits too early and cutting losses too late”
• Misses long-term compounding opportunities for high-quality assets

• Overestimates one’s ability to obtain information and make analytical judgments
• Excessive trading leads to higher transaction costs and lower returns
• Studies show overconfident investors trade 45% more frequently than rational investors, with annual returns 1.5-2 percentage points lower

• Selectively focuses on information that supports one’s views
• Ignores counterevidence and warning signals
• Leads to excessive concentration of portfolio risk

• Uses purchase cost rather than intrinsic value as the decision benchmark
• Hinders rational stop-loss and timely portfolio adjustment

• Chases rises and sells falls, making wrong decisions during market extremes
• Fully reflected in the 2000 dot-com bubble, 2008 financial crisis, and 2021 cryptocurrency frenzy

Academic research shows behavioral biases have cumulative damage to investment performance:

• Excessive trading costs
  : Frequent-trading household investors have annual returns 6.5 percentage points lower than the market
• Poor timing ability
  : Investor sentiment indicators show retail investors have a clear tendency to net buy at market highs and net sell at lows
• Compound destruction effect
  : If behavioral biases reduce annual returns by 2%, wealth will decrease by about 32% after 20 years

Value investment theory (Graham-Buffett system) is logically perfect, but still faces many behavioral challenges in practice:

• Over-reliance on static valuation metrics (low P/E, P/B)
• Ignores “value-destroying” factors like industry structure changes and technological substitution
• Cases: Retail industry (Best Buy, J.C. Penney) and newspaper industry post-2010s

• Leaves too early after the investment target reasonably returns to valuation
• Misses long-term growth premium of “good companies”
• Munger noted: “The most profitable stocks are often those held the longest”

• Distorts “independent contrarian thinking” into “being contrarian for the sake of being contrarian”
• Stubbornly adheres to invalid investment arguments
• Ignores “the market may be right at a specific time”

• Overconfidence after success, blindly expanding competence circle
• Excessive diversification across industries and markets
• Buffett warned: “Knowing your competence circle is more important than knowing its boundaries”

✓ Investment Decision Checklist
  ✓ Is the margin of safety sufficient (>30%)?
  ✓ Is the company's competitive advantage sustainable?
  ✓ Is the management team honest and highly competent?
  ✓ Is the industry structure stable?
  ✓ Is my cognition based on facts or opinions?
  ✓ Am I caught in the "sunk cost fallacy"?

✓ Mandatory Cooling Period
  - Wait 24-48 hours before major decisions
  - Pause trading during volatile market fluctuations
  - Regularly (quarterly) review portfolio logic

✓ Reverse Thinking Process
  - "Under what circumstances would my investment argument fail?"
  - "How would the smartest bears view this target?"
  - "If I had to hold it for 10 years without trading, would I still buy it?"

• Diversified information sources
  : Avoid information cocoons, actively access different viewpoints
• Focus on “abnormal” facts
  : Attach importance to data points inconsistent with mainstream narratives
• Distinguish between “facts” and “narratives”
  : Facts are objective existence; narratives are man-made interpretations
• Use probabilistic thinking
  : Investment decisions are based on “expected value” rather than “certainty”

• Accept uncertainty
  : The world is a probabilistic system; there is no 100% certainty
• Understand the power of compounding
  : Patience is the core competitive advantage of value investors
• Delay gratification training
  : Extend decision-making time from “today” to “ten years”
• Emotional marking awareness
  : Pause decisions when experiencing strong emotions (greed/fear)

• Maintain moderate concentration (5-15 targets), balancing competence circle and diversification
• Establish a “core-satellite” structure: Core positions (60-80%) hold high-quality enterprises
• Regularly (annually) conduct “zero-based thinking”: If I were empty-handed now, would I buy these targets again?

• Follow the “industry first, company second” research path
• Establish a standardized research framework to reduce randomness
• Mandatorily record investment decision logic for post-audit

• Read behavioral finance works such as “Investment Psychology” and “Thinking, Fast and Slow”
• Regularly review investment mistakes and build an “error case library”
• Communicate with rational, professional investment partners to break cognitive isolation

The user-mentioned “cyclical thinking” is a key tool to overcome behavioral biases:

• Kondratiev Long Wave (50-60 years)
• Juglar Cycle (8-10 years, equipment investment)
• Kitchin Cycle (3-4 years, inventory cycle)

• Howard Marks’ “Cycles”: From despair to doubt, optimism, euphoria, then back to pessimism
• The greatest contrarian allocation opportunities occur during market extremes (extreme greed/fear)

• Introduction → Growth → Maturity → Decline
• Different stages require different valuation methods and investment strategies

• No eternal winners
  : Even the best companies will experience slowing growth
• No eternal losers
  : Extreme pessimism often breeds reversal opportunities
• Only valuation prevails
  : Price below value is the only margin of safety

As Howard Marks of Oaktree Capital said: “We cannot predict the future, but we can prepare for it. Cyclical thinking helps us be greedy when others are fearful and fearful when others are greedy.”

The user-mentioned “70% mindset, 30% ability” accurately reveals the essence of investment success:

:

• Basic financial analysis
• Simple valuation models (DCF, comparable companies)
• Industry research methods

:

• Human nature tends to short-term satisfaction
• Market fluctuations continuously test psychological resilience
• Social pressure reinforces herd behavior

:

1. Know yourself
   : Identify your behavioral patterns through review
2. Systematic resistance
   : Use rules, checklists, and processes to constrain impulsive decisions
3. Long-term perspective
   : Treat investment as a lifelong career rather than a short-term game
4. Humble learning
   : Admit cognitive limitations and maintain an open mindset
5. Respect cycles
   : Understand everything has cycles; no one can beat the laws

Investment is a practice of cognition and character. As Munger said: “Rationality is the highest form of morality.” The core competitive advantage of value investors is not stock-picking skills, but the ability to remain rational in extreme market environments.

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[1] Kahneman, D., & Tversky, A. (1979). “Prospect Theory: An Analysis of Decision under Risk” - Econometrica
[2] Barber, B. M., & Odean, T. (2000). “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” - Journal of Finance
[3] Howard Marks (2023). “Mastering the Market Cycle: Getting the Odds on Your Side” - Market Cycle Research
[4] Charlie Munger (2022). “Poor Charlie’s Almanack” - Munger’s Investment Wisdom
[5] Daniel Kahneman (2011). “Thinking, Fast and Slow” - Foundations of Behavioral Economics