5 psychological biases that could affect your investments

Most of us try to approach investments logically, but sometimes our biases take over and hurt our portfolio.

“Doing well with money has a little to do with how smart you are and a lot to do with how you behave “

-Morgan Housel

 

Investing is a long-term game, and its rules aren’t nearly as complicated as they appear. Just like any other area in life, consistency is always at the core of everything. But what could come in the way of your perfectly planned investments are your behavioral biases.

Following an investment discipline that aligns with your long-term goals can feel tedious at times. And it might even lead to FOMO. You might get influenced by hot tips or fall victim to biases that can affect the growth of your investment.

1. Confirmation bias

Confirmation bias is the tendency to seek information that confirms your existing beliefs while ignoring information that opposes these beliefs.

Confirmation bias in investing can cause you to stick to previous assumptions about their investments while dismissing information that contradicts their notions. It may lead to over-investing in a particular stock or sector. 

This can make you vulnerable to a company or sector-specific downturns, which in turn can leave your portfolios misaligned with your long-term goals and risk profiles.

2. Group Thinking

This bias, also known as “herd mentality,” occurs when you seek acceptance or support from a group by aligning your investment decision with that of the group members. 

When members of a group reach an agreement without considering alternate ideas, it is referred to as groupthink. This consensus occurs because the members of the group lack the patience or capacity to reach diverse viewpoints.

When it comes to investment decisions copying the group’s investment choices will only hurt your individual investment goals. These group investment picks might not be adequately studied, work for specific investment goals, or worse, can be incorrect.

3. Recency bias

Recency bias is the tendency to overestimate the importance of recent experiences in your memory, even if they are not significant or accurate.

Recency bias can be difficult to eliminate in the world of investment. Recency bias occurs when investors make judgments based on recent occurrences and expect those events to continue in the future. It can cause them to make irrational actions, such as investing in a hot investment trend or selling shares during a market fall.

4. Familiarity bias

Familiarity bias occurs when an investor prefers a familiar investment over other feasible possibilities that can also contribute to portfolio diversification. An asset they have previously held and had a favorable experience with can feel less risky, and hence is frequently the “go-to” asset when looking to generate returns. 

As a result of familiarity bias, portfolio construction and thus investing outcomes can be significantly influenced. It has the potential to cause investors to rule out a wide variety of viable assets. 

5. Risk aversion

Risk aversion is the avoidance of risks or the chance of loss; this is reflected in their financial choices. Risk-averse investors will favor less risky options, such as fixed income over equity, large-cap over mid-cap, and so on.

Nobody wants to lose money, but risk aversion might cause you to lose more money on earnings or make less money than you expected to make. Risk aversion can be avoided by avoiding becoming overly emotionally involved in your investments. Investing carries risks, many of which are beyond your control, and you cannot be correct all of the time.

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