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When it comes to managing money, you may not think that underlying biases play much of a role. After all, we all like to believe that we’re rational and logical people who are capable of making clear decisions. Unfortunately, no matter how objective we like to think we are, at the end of the day, we’re only human. As such, we often make decisions based on biases that we aren’t even aware of. If you want to be able to invest your money effectively, it’s important to know what these are and how they can affect you. Read on to find out the five most common biases that could have an impact on your decisions.
1. Hindsight bias
One of the most common biases that can affect your investing is the tendency to consider past events as being predictable, but not future ones. As you might imagine, this can be a dangerous bias as it can stop you from objectively assessing your past decisions. For example, you might be able to convince yourself that you knew a market downturn was going to happen long before it did. In reality, however, it can be very difficult for even the most well-informed investor to predict these things. The biggest problem that this can lead to is that it makes it hard to learn from the past. This can sometimes lead you to make riskier investments in future.
2. Trend chasing
Another major emotional bias that can affect your investing habits is the risk of chasing trends. As we’ve often said before, the past performance of an investment is no guarantee of future success, but people inclined to chase trends can often ignore this advice. One of the most memorable examples of this trend involved GameStop in early 2021. According to the Guardian, the price of the company’s stock surged by 1,700% at the height of the bubble, but swiftly fell again when it burst. The sudden rise meant that many investors followed the trend and bought in, with the hopes of seeing strong returns. However, when the share price crashed, a large portion of them lost money. When you invest, it’s important to bear in mind that just because a company has performed well in the past doesn’t mean it will again, especially when circumstances have changed.
3. Loss aversion
To put it simply, this is the idea that people have a tendency to consider avoiding loss as more important than achieving gains. This is because humans feel the pain of loss more strongly than the pleasure of a gain. This can skew your thinking as, when you make a gain, you may not give it much thought and simply move onto the next investment. However, when you make a loss, you may take it personally as a serious failure of judgement. The main problem with this is that it can lead to an inconsistent investing strategy, as you subconsciously aim to avoid the stress of loss. As a result, you may be too risk-averse for your own good. For example, you may not sell an asset that is making a loss, in the hope that one day it may rise in value. This means that instead of losing a small amount of money now, you may be setting yourself up to lose a large amount later.
4. Confirmation bias
This is one of the most common emotional biases that you may hold. It essentially involves making important decisions based on your pre-established assumptions and not factual evidence. The best way to understand this bias can be with newspapers, as you probably read one that aligns with your political beliefs. For example, depending on your views, you may prefer the Guardian to the Times. Generally, people tend to look for information that supports the beliefs they already hold. While this can sometimes be harmless, if it affects your investing strategy then it could potentially result in you losing a significant amount of money. For example, if you believe that a particular asset will grow, you may be unknowingly drawn to information that validates this belief. Conversely, you may also ignore evidence that goes against it. As you might imagine, this can have a profound effect on your investing strategy.
5. Regret aversion
Regret aversion essentially means that the fear of making the wrong decision can mean that you don’t take proper advantage of investing opportunities. While the logic is disordered, it is understandable – if you don’t make any decision, you can avoid the regret you may feel by making the wrong one. When it comes to investing your wealth, it’s natural to feel some degree of worry over the performance of your portfolio. That being said, however, this anxiety shouldn’t paralyse you into inaction. One of the main consequences of this nervousness is that you may be investing in an overly safe way. While this can give you a greater feeling of security, this doesn’t mean that this level of risk-exposure is right for you.
Get in touch
If you want to be able to grow your wealth through investing and want to be able to make properly informed decisions, we can help. Email us at office@verve-financial.com or call 0330 320 5048.
Please note:
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.
