If you’ve ever bought gold in a hurry or bought stock just because all your colleagues bought it, or sold prime land because your intuition told you it was a bad investment, you are victims of biased behavior. Behavioral biases arise because your emotions influence your investment decisions.
How many times have you intuitively felt that an investment is good or bad? There’s a good chance that you don’t like certain types of investments and prefer others. What investors tend to do in such cases is look for information that might justify their subjective feelings or decisions.
This unexplained bias toward some types of investments and aversion to others can lead to what is known as confirmation bias. As an investor, you can be mistaken in making bad investment decisions and miss out on potential opportunities that you missed just because of your tip.
When making investment decisions, when trying to fit into a group by reflecting the group’s investment choices, be aware that those investment choices may not have been adequately researched or worse.
Recent Hit Bias
This is a bias that steers most investors in the wrong direction. The human brain has more weight on recent events than on past events. As a result, a recent event disproportionately affects your investment decision-making.
This causes investors to exit after a bear market and run into safer investments, or enter after a bull market begins when in reality they have to do the exact opposite. Recent bias makes investors forget the golden rule when making investment decisions: buy low, sell high.
If recent trends are the father of poor investment decision-making, familiarity bias is the mother. This is the second most important group of needs in Maslow’s hierarchy of needs.
Finally, risk aversion plays a very important role in making investment decisions. Investors vary widely in their tolerance for risk. An investor is very risk-averse if their risk tolerance is low. On the contrary, they have high-risk tolerance (or low-risk aversion) if risk tolerance is high.
While risk aversion follows a continuous spectrum, think of it this way: When investing, are you looking to maximize profits or minimize losses? If you’re in the latter category, you’re at a higher risk of losing returns, especially when adopting a portfolio approach to investing.
What matters in investment decision-making is only researched opinion, not subjective feelings or emotions. Recognize your biases, research well, and only then dive into investing.