4 psychological biases that could affect your investment behaviours
These 4 psychological biases could have a negative impact on how you invest. Read about each of them and discover why independent advice matters most.
With so much investment information at your fingertips, you might feel more confident than ever about your investment choices.
After all, you can research fund options, look at historical charts, and assess the performance of different stock market indices at the touch of a button. How could you possibly go wrong?
The truth is, according to a new study by the National Institute of Health (NIH), having more information doesn’t necessarily lead us to make better choices. In fact, some of the findings suggested that additional information leads to worse decision-making.
What’s more, even with all the “right” information available, this doesn’t mean our human biases are pushed to the side. We often have preconceptions – either inherited or learned – that sway us in a certain direction without us even realising it.
So, even if you feel like you’re making all the right choices, it’s crucial to be aware of bias and how it might have an impact on your investment habits.
Let’s take a look at four psychological biases that typically affect investors.
- Loss aversion – the concept that the impact of loss is greater than the satisfaction of a gain
Last year, we published a blog on how loss aversion could make investors risk-averse, and even increases the likelihood of panic-selling during periods of market volatility.
To recap, loss aversion is a psychological bias that makes losing something – in this case, money – much more painful than the joy you would feel by gaining the same amount.
In an example, imagine you dropped a £50 note down the drain. You would likely feel incredibly frustrated, knowing that the money will have gone to waste forever. You might even go home and tell your spouse and children about it, venting your frustration and blaming yourself.
Alternatively, if you won £50 on a sports bet one Sunday afternoon, you may feel happy, but you might not feel the need to shout from the rooftops.
That’s because, according to the psychologists who coined the term, loss aversion is a hard-wired bias designed to keep us safe from risk.
Our ancestors might have benefited from this bias, avoiding unnecessary risks and preserving important resources. But today, investors could find themselves suffering at the hands of this bias, being more prone to panic-selling when their portfolio dips, and feeling “just fine” when its value rises as planned.
- Confirmation bias – agreeing with evidence that supports your pre-existing point of view
You have probably heard of confirmation bias before. This occurs when something – a person or event – reaffirms beliefs you already held, making them even more concrete.
For example, if you believe property is the “best” type of investment a person can pursue, and hear a friend talk about the financial success they have achieved through property investments, this reaffirms your view. In turn, you might be more likely to pursue that type of investment without properly considering the risks and potential pitfalls.
On the other side of the coin, if you are nervous about investing, you could find yourself researching stories about those who “lost everything” on the stock market. Your bias is then confirmed: investing is “dangerous”.
As an investor, there is nothing wrong with sharing your experiences and doing research into the type of asset you are interested in. But confirmation bias could skew your opinion and lead you to taking unnecessary risks (or indeed, prevent you from taking strategic risks that could pay off later).
- Herding bias – following what others are doing
Following the herd is a natural human bias that has kept us safe for generations. Nobody feels comfortable “striking out alone” as it makes us vulnerable to the unexpected.
However, herding bias could be detrimental to investors, especially in the age of mass media.
If you use social media platforms such as Facebook, you might find yourself bombarded with “advice” from “experts” in certain topics, including finance. These people might encourage you to “act now before it’s too late” – for instance, selling investments while the stock market falls to avoid future losses. Such a post could have hundreds of comments, all written by those who support this person’s point of view.
By allowing yourself to be influenced by the herd in this instance, you could make detrimental investment decisions that harm your wealth long-term.
It’s natural to want to follow what your friends and family recommend. However, discussing your personal goals with a professional could be more suitable where investing is concerned. A financial planner can assess your unique ambitions, talk to you about your risk tolerance, and form a bespoke solution that is right for you, despite what the “herd” says.
- Anchoring bias – the tendency to agree with the first, most memorable piece of information we learn
Anchoring bias describes the unconscious act of latching onto the first piece of information we receive about a certain asset.
For example, you could read a report that says a certain technology company has hired a new CEO who will revolutionise the business and take it to new heights. It’s predicted to be the next big thing on the stock market.
You might then see other reports to the contrary, with some forecasters expressing concerns about the company’s longevity. But the initial positive report sticks in your mind, and you decide to invest anyway.
Your decision might turn out to be the right one (or it might not). The point is, you can’t predict the future, yet your anchoring bias could have you convinced that the investment can’t fail.
So, taking a more measured approach – investing over the long term in a broad range of assets, rather than timing the market or following the latest trend – may be much more suitable for you.
Your financial planner can help to identify bias and offer impartial advice
As experienced, independent financial planners, our job is not to recommend investment pathways we “like”. Our job is to do the research, listen to your goals, and come up with a bespoke solution suited to you and you alone.
If you are concerned that bias could be affecting your decisions as an investor, or you simply want to learn more about the benefits of our investment management service, get in touch with us today.
Email us at hale@kelland.co.uk, or call 0161 929 8838.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
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.