The Real Key to Investing: Being Aware of Your Behavioural Biases

What is a Behavioural Bias?

Humans are not always able to act rationally. These biases can be seen in small decisions like when you only want a burger but instead upgraded to a full meal and ended up spending $4 more than you wanted or needed to.

Most of our decisions can easily be affected by behavioural biases. Behavioural biases are irrational beliefs or behaviours that can unconsciously influence our decision-making process. There are two main categories — emotional biases and cognitive biases.

Emotional biases involve us taking action based on our feelings rather than facts. Cognitive biases are gaps in our thinking process when we evaluate and interpret information. Multiple biases could be at play when you’re making a decision.

Here are five common behavioural biases to look out for when making investment decisions:

Loss Aversion

We tend to feel the pain of losses twice as intensely as the joy of an equal gain. Meaning the loss of $1000 hurts twice as much as a gain of $1000. This bias is why you are drawn to phrases like “LAST CHANCE” or “DON’T MISS OUT” which tap on the inherent fear of missing out.

In investments some people may invest because they think they might lose out. Make sure you invest in something because it is a viable investment. Also be aware of recognising your gains in addition to your losses so that you don’t feel like you’re always on the losing end all the time.

Anchoring Bias

This bias is a tendency to be over-reliant on the first piece of information you hear. For instance, when you hear that a particular restaurant is overpriced, you tend to stick to that information. You would almost always link your impression back to this first piece of information. So, even when prices have changed or the prices were actually reasonable to begin with, you tend to think of this restaurant as overpriced.

Likewise, when you have an impression of a specific stock or instrument, make sure you follow the latest updates rather than sticking to an outdated anchor information that may not be well supported.

Overconfidence Effect

Being too confident in your abilities can lead to taking excessive risks. When you are given an assignment, you might overestimate your abilities to finish it faster than you can and delay it to tomorrow. But you may find yourself stressing and frantically trying to complete it the next day, that’s the overconfidence effect.

This bias applies to investments too. When you’re overconfident about your investing skills, you may end up putting in more money than you can stomach to lose. A healthy dose of humility and mindfulness is needed to combat this.

Awareness Is Key

Investors exhibit many behavioural biases that may hamper them from making accurate investment decisions. To avoid falling for such biases, it is important to be aware of their existence and engage in objective investment strategies. By first developing and following strictly to a plan, you are less likely to make financial decisions based on impulse. Also, a simple rule of thumb when conducting your investment research will be to actively question your own opinions by seeking out contrary information that refutes them.

Originally published at https://plannerbee.co on October 2, 2019.