Don't Let Your Emotions Steer the Investment Boat: Common Biases to Avoid
Our biases can cloud our investment judgement and lead to poor choices. This article explores 18 common emotional biases that trip up investors, along with tips to mitigate them. Recognize these biases and employ critical thinking for smarter investing. Successful investing is about self-control and common sense, not a high IQ. By being aware of biases, you can navigate the investment waters with greater confidence.
Femwealth Team
Last updated 10 Jan 2025
The world of investing can be a thrilling adventure, but it's also filled with hidden dangers. These dangers aren't just lurking in the form of volatile markets or unforeseen events. Often, the biggest threats to our investment success come from within ourselves – our own biases biases- lurking like crocodiles beneath the investment waters. They can cloud our judgment, lead to impulsive decisions, and ultimately, sink our financial goals.
The good news? By recognizing these biases, you can steer clear and make investment decisions based on logic, not gut instinct. Here's a deep dive into some of the most common emotional biases that trip up investors, along with actionable tips to keep them in check:
1. Small number bias
Think a single data point tells the whole story in finance? Big mistake! Small numbers bias leads to big decisions based on limited information. Don't be fooled by a stock's rise - it might not reflect the entire industry. Imagine buying all car stocks because Toyota's up. What if it's a one-time event?
2. Cognitive Dissonance
Cognitive dissonance refers to the mental discomfort we experience when our beliefs clash with new evidence. Imagine you've always viewed your bank as a safe and reliable institution. But now your bank's stock might be sinking, but you still regard it as the gold standard since you believe it is the best bank around.
3. Familiarity bias
Familiarity bias is a mental shortcut where we favor things we understand and feel comfortable with. In investing, this means sticking to known options like FDs, even if potentially higher returns exist elsewhere, like mutual funds or real estate.
4. Pessimism bias
Pessimism bias is when lack of confidence and an emotional "low" makes you do weird things. You overestimate the likelihood of negative events and underestimate positive ones.This can lead to excessive caution and missed opportunities for growth.
5. Optimism bias
Optimism bias is when overconfidence and an emotional "high" make you do weirder things. It's that tendency to overestimate positive outcomes and underestimate negative ones, often fuelled by a surge of confidence and excitement. This can lead to taking on too much risk and chasing hot trends without properly researching.
6. Reference Point bias
Reference point bias occurs when investors evaluate the performance of an asset based on a non-relevant comparison, like comparing an apple to an orange instead of its peers. This bias can lead you to make flawed judgments about the value or potential of an investment.
7. Anchoring bias
This bias refers to the tendency for investors to rely heavily on initial information or a specific reference point when making investment decisions. For example, if you fixates on a historical price without considering current market conditions or fundamental analysis, it can lead to suboptimal decisions.
8. Endowment bias
Endowment bias refers to the tendency for investors to rely heavily on initial information or a specific reference point when making investment decisions. For example, if an you fixates on a historical price without considering current market conditions or fundamental analysis, it can lead to suboptimal decisions.
9. Status Quo bias
This bias is you being static, stale, in your comfort zone, sitting on the couch eating chips, and not getting up because you hate change i.e. you invest in the same stocks and funds without looking at fresh prospects.
10. Representative bias
It refers to the tendency to make quick judgments about an investment based on its superficial resemblance to previous successful or familiar opportunities.
11. Mental Accounting
It refers to the tendency to make quick judgments about an investment based on its superficial resemblance to previous successful or familiar opportunities.
12. Disposition Accounting
This can be likened to the tendency to sell winning stocks prematurely out of fear of losing gains, while holding onto losing stocks in hopes they will rebound, even if their fundamentals deteriorate.
13. Risk Addiction Bias
This is the thrill seeker in action who takes a risk and after that will take successively greater risks, it does not matter whether the first few risks paid off or not, it is that addiction...
14. Gamblers Bias
is when the gambler in you sees the markets rising for a few days in a row and expect the same going forward. You make your investment decision based on this "momentum".
15. Attachment Bias
This refers to making investment mistakes because we are... well attached to something for whatever reason e.g. the first computer I worked had Windows, so I will only buy Microsoft stock.
16. Media Bias
This bias is you and me forming strategies, making decisions, and being influenced by opinions of people we see on TV, read in newspapers. In reality, most of these media geniuses give terrible advice for investors.
17. Overconfidence Bias
This is easy: you think mistakenly you are a better investor than others (for whatever reason: experience in investing, subject matter expert in a particular field, you have read all the right books, you are a MBA, CFA etc.
18. Experiential Bias
This bias is your personal experience of recent market events (say a sharp drop in the market led to huge losses and scarred you) making you feel that the same event would repeat, thus clouding your judgment (you are now scared of investing in equity.
Mitigate investing bias with these smart strategies
Know your risk tolerance.
Diversify your portfolio.
Focus on long-term goals.
Do your research about market and different investment options. Research & base decisions on facts, not emotions.
Set realistic expectations. The market has ups and downs. Aim for steady growth, not get-rich-quick schemes.
Develop an investment strategy that aligns with your goals and risk tolerance.
Wow. Wasn't that a whirlwind tour? Just wanted to give you a taste of all the crocodiles swimming in the river. Turns out most of those crocs are us.
Another reason why the real investment gurus say that you don't need a high IQ to succeed in investing. You need self-control and common sense which is not common at all.
Takeaway
This is just a sampling of the many biases that can cloud our investment judgment. Recognizing these biases is the first step towards overcoming them. By employing critical thinking, conducting thorough research, and developing a sound investment strategy, we can navigate the investment waters with greater confidence and avoid the clutches of the metaphorical crocodiles.
Subscribe to She Invests
A weekly newsletter filled with money tips & insights, curated for women.
Related posts
In the world of personal finance, two terms get thrown around a lot: saving and investing. While they may seem interchangeable at first glance, they serve distinct purposes in your financial journey. This blog post will dive deep into the difference between saving and investing, why you need both, and how they can work together to help you achieve your financial goals.
Setting money boundaries empowers you to make smart financial decisions and achieve your goals. This article provides 10 powerful strategies to establish healthy money habits, including setting spending limits, creating separate accounts for different goals, and talking openly about money with loved ones. Learn how to take control of your finances and build a secure future.