Certain investment biases come from different sources and occur for different reasons. While discipline and patience positively impact the investing journey, biases can be an investor’s worst enemy.
Here are four common biases in the investing space you should know about and how you can combat each one of them.
1. Herd Mentality Bias
In investing, herd mentality refers to the habit of following and doing the same action taken by other investors. This type of mentality can hinder proper decision-making, as it pushes you to go with your gut feeling instead of relying on your own analysis to make a decision.
While it’s true that some investors end up pursuing financial instruments that others invest in, hoping that such a move will help them earn and that the market will not move against them, the strategy of following the crowd or your peers can lead to a tragic outcome.
The Right Thing to Do: Before investing in any financial instrument or product, make sure to learn about its structure, the associated risk, and growth prospects. Simply put, avoid following and copying other investors’ actions, but make your own path.
2. Recency Bias
Investors display recency bias when they make decisions based on recent happenings. In this bias, investors tend to focus more on the latest events. While that’s not a bad thing, it’s not a good thing either, since it could make you forget that the past is as important as the present.
The Right Thing to Do: Don’t just rely on short-term trends and think about what may happen in the future. Knowing how long you should stay invested without being persuaded by short-term trends is crucial.
In addition, having your own investment strategy and sticking with it is another way to combat recency bias. You also need to have a good grasp of the markets and determine your financial goals properly so you can invest accordingly.
3. Confirmation Bias
Called the mother of all biases, confirmation bias is an investor’s tendency to find information that only supports his beliefs and expectations and immediately disregard any information that would dispute them.
This bias is one that you should fight off at all costs because it would not only take away your ability to think rationally. It could also make you overconfident, which can work against your investment success, providing you a false sense of control and curbing your potential returns.
In other words, confirmation bias gives you an illusion of hope that could make you invest in an asset with poor qualities or continue holding a loss-making investment, expecting that things will eventually get better.
The Right Thing to Do: It pays to be open-minded when it comes to investments. Whether the data or information supports or contradicts your beliefs, it’s important to consider every fact possible.
4. Loss Aversion Bias
While it is better to have winners, the thought of losing could completely change investors’ focus from turning a profit to avoiding losses. As a result, they miss opportunities that would have increased their gains. Trying to prevent losses can damage your wealth-building over the long term.
Also, loss aversion bias makes investors stay invested in loss-making instruments with hopes of avoiding a loss. However, such a decision will only reduce the overall returns and hold you back from having financial security.
The Right Thing to Do: Always keep in mind that looking for opportunities that amplify gains is just as vital as using strategies that minimize risk.
