What is a behavioural bias? It’s simply a mental shortcut that our brains take when making decisions. These shortcuts can help us to make quick decisions in everyday life. However, these types of shortcuts can often lead us astray when it comes to investing.
We are constantly susceptible to behavioural biases that can lead to poor decision-making. For investors, this can be disastrous, as it can cause them to act impulsively or irrationally, leading to poor financial outcomes.
This blog post will look at some of the most common behavioural biases and discuss how they can affect investor behaviour. We’ll also provide some tips on overcoming these biases to make more informed investment decisions.
Confirmation Bias: We’ve all been there – we decide and then go looking for information that supports our decision, rather than taking a step back to consider all of the available evidence. This is called confirmation bias, and it can be dangerous when it comes to investing. We might miss important red flags or warning signs when we only look for information that justifies our already-made decisions. This can lead to costly mistakes.
Pro Tip: Take your time and consider all available information before making a choice. Gather data from multiple sources and get input from your financial advisor. By taking a more holistic and considered approach, you can avoid confirmation bias and make educated investment decisions that are more likely to pay off in the long run.
Herding Bias: When it comes to investing, there’s a lot of pressure to conform. Every day, we’re bombarded with headlines telling us which stocks are hot and which are not. It’s easy to get caught up in the herd mentality and make investment decisions based on what everyone else is doing. However, this can be a dangerous trap to fall into. When everyone is rushing into a particular stock or market, it often means that prices are about to peak. And when prices start to fall, herding investors often sell in a panic, leading to even more losses.
Pro Tip: Stay focused on your own goals and objectives. Tune out the markets’ noise and make decisions based on research and analysis. By staying disciplined and keeping your eye on the long-term, you’ll be less likely to follow the herd and more likely to achieve your financial goals.
Pessimism Bias: Pessimism bias, or the disposition effect, is a well-documented phenomenon that affects investors in the stock market. This bias causes investors to sell stocks prematurely in anticipation of adverse events that may or may not happen. The disposition effect can have disastrous consequences for the economy. For example, if many investors sell their stocks in anticipation of a recession, this can create a self-fulfilling prophecy, leading to an actual recession.
Pro Tip: Remain aware of our own emotions and how they might be affecting our investment decision-making. Seek objective research and advice from a financial professional who can help you to maintain a long-term perspective. Investor education and awareness are also critical to help mitigate the effects of this bias.
Short-Term Thinking Bias: When the stock market begins to go in a negative direction, it might be easy to make judgments based on feelings, particularly fear. This behaviour is often called “short-term thinking bias,” and it can cause people to make mistakes that cost a lot of money.
Pro-Tip: First, stay calm and don’t panic. It’s important to keep a level head when the market starts to dip. Remember that corrections are a normal part of the market cycle. Second, avoid making impulsive decisions. Resist the urge to make rash decisions based on fear or greed. Instead, take a step back and evaluate the situation logically before making any moves.
Every one of us has emotional biases that influence our financial decisions. The good news is that knowing about these biases is the first step in getting ahead of them.
When it comes to investor behaviour, to make more informed decisions, it’s critical to go through your financial plan frequently, especially if you notice certain biases sneaking in. Take a step back and reassess your financial plan, especially are getting stressed over market swings or feel compelled to make rash actions. Reminding yourself of your long-term goals and objectives will help you stay focused on the big picture while keeping your emotions at bay.
