There is no universal rule book for making investments. Depending on your financial situation, exposure, access to market information, and faith in financial advisors – you will make investment decisions that will stand unique from the people around you. However, more often than not, you will make judgments that will stem from behavioral biases. Explore the four most commonly occurring behavioral biases that exist around you and ways you can avoid them in the first place.
1. Chasing Trends
How often are you tempted to do certain things that your friends/family/colleagues have done? I’ve observed this behavior where some of my clients want to replicate the ‘success stories’ heard in their social circles.
This mindset of chasing trends is a serious issue primarily because you hear stories from people who you cannot ask for validation about facts or resources. This half information can adversely affect your portfolio as your finances, risk appetite, and goals will differ from those around you.
In fact, a study from the University Of California found that investors who made decisions based on past performances were often the poorest performers in the lot.
Protect yourself from herd mentality by implementing this step:
Process all the information heard/received from your peers and conduct an objective evaluation through solid research. Understand company fundamentals, performance & projections, market sentiments and then make your call.
No matter how experienced you are in the investing space, the adrenaline rush of making money from investments is a joyful experience. However, this happiness can give rise to overconfidence that leads to making impulsive or non-rational decisions, causing significant losses. This overconfidence often branches into the quality of information owned and one’s ability to act on it at the right time to earn maximum profits.
For example, Alex has just started investing in cryptocurrency where he is utilizing his immediate resources for making decisions. He ends up making money from his first attempt. This success boosts his confidence, motivating him to take a bigger position in the next round. While this decision also rules in his favor, he soon develops overconfidence, which is eventually reflected in his losses.
Apply this tip to avoid overconfident investments:
While overconfidence is both a conscious and sub-conscious takeover, it’s essential to always conduct proper research before investing. Ideally, you should consult a financial advisor for making sound portfolio decisions.
3. Anchoring Bias
More often than not, you must have noticed people over-valuing an initial piece of information to make a set of decisions in their lives. This anchoring bias is common in the investing space when people are caught in the web of making decisions revolving around the asset price without understanding their underlying value.
Let’s unfold Stephanie’s bias where she holds onto a stock bought at $150 and refuses to sell at the current market value of $120. She waits until the market corrects and sells at $145 after three years. While there was no difference in selling at these prices over three years, her bias led her to put more weight on the price difference versus the value she would’ve otherwise received.
Avoid falling into the anchoring bias trap like this:
Sit with your financial advisor and conduct a 360-degree assessment of the stock/security under question. Understand their price and value enrichment and accordingly map your investing strategy.
4. Loss Aversion
Which of the following two situations impact you the most?
- You’ve received a 10% profit from your investments.
- You’ve incurred a 10% loss in your portfolio.
Did the loss hurt more than the joy received from the profits? If you answered yes, then you’re bounded by the behavioral bias of a loss aversion. Here, people react more sensitively to losses than to counteractive gains. This bias of avoiding losses is so strong that it pulls back potential investors from dipping their finances into investing instruments. Such people prefer savings over investments while failing to factor in the rising inflation that will reduce the overall value of the money.
I encourage you to fight behavioral bias like this:
Let your strategic side overpower your emotional thoughts. Consult a financial advisor to get an objective and best strategy to grow your wealth to secure your future.
We all are here to maximize our gains and reduce losses. And as I always say, one can build wealth and live a comfortable life by making investments. However, as humans, we are subject to such behavioral biases that impact our portfolios and mindset.
While there is no way to eliminate such biases, you can make a conscious attempt to protect yourself. If you could relate to the above biases or want to chalk out a more strategic plan for yourself, reach out to me through this form and I will get in touch at the earliest.