When it comes to investing, most investors tend to consider themselves rational individuals. But even for the well-informed, investment decisions can be influenced by certain emotional biases. Here are some common ones to consider.

Confirmation bias

Many investors fall into this ‘trap’ from time to time, especially when they become too emotionally invested in a particular viewpoint or strategy.

Here’s a practical example. Let’s assume you have researched and invested in renewable energy companies. Subconsciously, you might begin to pay more attention to news articles praising advancements in renewable technology, while dismissing reports that question its long-term viability.

English psychologist Peter Watson called this selective perception ‘confirmation bias’. When it comes to investing, a confirmation bias can lead investors to ignore financial data and hold on to underperforming investments.

So, how can you overcome this? It’s always a good idea to form an opinion based on multiple sources of information. And of course, consult with your financial adviser: we can help you put things into perspective and focus on your strategy.

Recency bias

Recency bias is based on the assumption that current trends are the best predictors of future performance.

As any savvy investor knows, this is far from the truth, but sometimes emotion overrides logic. For example, you might heavily invest in a sector that has recently been doing well, assuming that the uptrend will continue into the foreseeable future.

As Morningstar reports, what happened during the 2008 GFC is a real-life example of recency bias in action, as investor behaviour was largely driven by recent share market performance rather than longer-term patterns.

Would you like to avoid recency bias? One key thing you can do is implement a diversified portfolio strategy, to minimise the impact of market volatility on your savings. Also, you might want to conduct historical analyses to identify cyclical patterns – with the help of your SHARE adviser.

Anchoring bias

Anchoring bias refers to the tendency to rely too heavily on the first piece of information one encounters (the “anchor”) when making decisions.

For example, you may have purchased an investment at a certain price. Now, you might be unwilling to sell unless you can recoup your initial investment, or unwilling to buy more unless the investment reaches a specific lower price. However, market dynamics change, and the initial price you paid may no longer be the investment’s market value. Rather than looking at fundamentals, your decision-making is influenced by anchoring bias.

To mitigate the impact of anchoring bias, it’s important to rely on current financial analysis, and evaluate investment opportunities based on a variety of factors – including fundamental analysis and market trends. 

Loss aversion

The term ‘loss aversion’ was coined in 1979 by psychologists Daniel Kahneman and Amos Tversky, as one of the key principles of decision-making under risk. Research found that losses generally have a bigger psychological impact than gains of the same size. So, people tend to be more risk-averse when faced with potential losses – even if the potential gains outweigh the risks.

Why is that? According to psychologists, loss aversion stems from our evolutionary history: protecting against losses has been more advantageous for survival than seeking gains. Plus, we might be socially conditioned to fear losing.

To counteract loss aversion when investing, consider periodically rebalancing your portfolio to ensure you’re not overly exposed to any single asset. Plus, you may want to create an investment policy statement that outlines your risk tolerance and long-term goals, serving as a guide for making emotion-free decisions.

Like to know more?

While you can’t eliminate biases entirely, you can mitigate their impact by understanding them and being proactive.

If you’d like to know more, get in touch. We can help you navigate these and other biases, and tailor a robust strategy that’s aligned with both your goals and risk tolerance.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.