The human mind is incredibly complex. For every choice, or action we make on the surface, there is a sprawling web of subconscious impulses influencing our decisions.
Taking steps to understand “why” you do things is a vital part of the human experience and is likely to help you ensure that your conscious mind remains in control of the important decisions in your life.
Last month, you read about the first part of our core mantra — “plan” — when you learnt about the emotional and financial wellbeing benefits of financial planning. This month, you can read about step two — “protect”.
There are times when your subconscious mind might be actively working against your best interests. This could lead to costly outcomes in the world of investing. So, it is important to identify prominent psychological biases and take conscious steps to mitigate their influence on your decision-making.
Here are five biases that you should be aware of to help you make better choices.
- Loss aversion
The theory of loss aversion posits that humans feel the pain associated with loss twice as intensely as any happiness produced by gains.
This bias can push you to act emotionally while under pressure and make knee-jerk decisions. This might involve selling an investment during an economic downturn to avoid potential further losses.
However, this can work to hinder your long-term plans, as it essentially converts what was initially just a paper loss into a definitive one — removing any possibility of your investment’s value bouncing back in the future.
Remember: In the world of investing, a calm and patient approach might yield better results, especially as markets typically bounce back from short-term dips and trend towards long-term growth.
- Confirmation bias
Confirmation bias relates to the human tendency to seek out information that supports a pre-existing belief or viewpoint.
This may lead you to neglect valuable steps, such as taking the time to properly research your investments. Instead, you may opt to rely on select information that reinforces a decision you were already in the process of making.
In investing terms, this bias could lead to you being blindsided by potential negative outcomes. For example, if an investment doesn’t work out due to confirmation bias pushing you to ignore information that could negatively affect investing outcomes in favour of data that solely backs up your initial decision.
It is vital that you don’t rush into any investments. There is value to be had in doing thorough, unbiased research, and discussing your options with a trusted adviser first.
- Anchoring bias
Fixating on small details can be a problematic mindset that stops you from observing the bigger picture. The anchoring bias is the tendency to focus too heavily on, or “anchor to”, a specific piece of information or reference point when weighing up a decision.
This may be something as simple as putting an inflated degree of importance on an investment’s recent share price, particularly in relation to its trading history.
However, a company’s share price in the present, as well as where it was in the past, doesn’t necessarily act as a reliable indicator of where it may end up in the future.
It could be worthwhile to sit back and take a wider view of your portfolio and how your investments factor into your goals, rather than spending too much time fixating on little details that may have zero influence on future outcomes.
Instead, opting to take a view of the bigger picture might help you maintain a more objective view of your investments and reduce any worries about the short-term ebb and flow of the market.
- The overconfidence bias
Overconfidence bias is a behavioural concept relating to people’s ability to overestimate their abilities. This might include an inflated view of our financial acumen.
The bias skews your perception by imbuing you with a sense that your innate judgement is far greater than its actual objective accuracy.
If you benefit from a series of short-term investments that produce generous returns, you may find yourself falling under the influence of this effect. This could leave you vulnerable to mistakenly believing you can predict the market — which very rarely happens — and that your investments are a certainty to produce gains.
It could be a smart move to seek out investment advice regularly to ensure you have a second opinion that helps you stay grounded.
- Herd behaviour
It can be called many names: peer pressure, sheep mentality or, most commonly in investing terms, herd behaviour.
This bias might cause you to follow the opinions or decisions of others, instead of making your own informed choices.
If you see your friends, loved ones, or colleagues investing heavily in a particular stock, you might feel the urge to follow suit out of fear of missing out on potential gains. However, this could adversely leave you exposed to losses.
If you are hearing a lot of buzz around a particular investment, take the time to research it, or consider reaching out to a professional for expert advice.
Get in touch
If you are unsure of what the best choices may be to help you to reach your investment goals, it could be a smart move to seek out a second opinion and gain some professional insights.
To discuss your plans, please reach out by email at beyourself@murphywealth.co.uk or give us a call at 0141 221 5353.
Please note
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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