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None of us likes to think of ourselves as biased, yet it is part of our human psychology. It is part of our evolutionary history, where it helped us in our primeval state to identify threats in nature. Today, however, our biases (disproportionate weight in favor of or against an idea or thing) can be harmful for endeavours that require objective thought and detachment from emotion – like investing. In this article, our financial planning team here at Hanson Financial Services (financial advice in Liverpool) identifies 10 common investor biases to watch out for, and what you can do about them regarding your own portfolio.
Investments naturally fluctuate in value, and this can lead people to pick an arbitrary “reference point” – or benchmark – to measure them against. This can cause an investor to keep holding onto an investment that has lost value, because their estimate of its fair price is anchored to the original price (rather than to the investment’s fundamentals).
This can refer to a range of mistakes: 1/. overconfidence in the information you have on an investment; 2/. Overconfidence on your capability to use it to make good decisions. This can be made worse by “confirmation bias”, where you selectively find information that merely confirms your pre-existing opinions about an investment.
#3 Herd mentality
When everyone around you is rushing towards something, it is difficult to resist the urge to follow along. This “herd mentality”, again, comes from our primeval desire to stay in a large group to keep safe from threats in nature. With investing, however, this can lead to “stampedes” upwards or downwards in a stock price, which do not reflect its fair value. You can counter this by having a long-term plan in place for your investments.
#4 Recency bias
How do you know whether something is likely to happen? For most of us, we believe it is more likely if that very thing happened recently. For instance, if a stock shot up in price yesterday, we may believe it will do so again today or tomorrow. Yet this is completely untrue.
Think of a card game – just because you got a full house on your previous hand, this has no influence upon whether you are likely to be dealt the same hand again. The same holds true for events in the stock market.
#5 Loss aversion
Most of us strongly prefer to avoid experiencing the feeling of loss rather than enjoy the feeling of reward/gain. When investing, this can lead to irrational decisions. In particular, selling a stock or fund which has recently dropped dramatically in price, but which has strong fundamentals – giving it a good chance of recovering and surpassing previous highs in the long term.
#6 Hindsight bias
We tend to look back on past “good” events and think that they were entirely predictable – even though, at the time, it was not clear that these would happen. Conversely, we tend to look back on “bad” events and blame them on something other than ourselves – e.g. unpredictable events! Instead, a better way forwards is to recognise and learn from past errors of judgement and not merely assign them to unpredictable market forces.
#7 Chasing trends
If you see a stock price chart going steadily down or up over a period of weeks or months, it is tempting to assume this will continue. As such, investors can get drawn into going “long” or “short” on a stock without looking carefully at its fundamentals. Whilst “momentum” can be an important factor when analysing an investment opportunity, there are many other factors at play to be aware of.
#8 Limited attention span
There are so many investments to choose from. This can lead investors to only focus on those which arrive in front of them due to emails, websites and media outlets. Yet there is a world of opportunity beyond the “well-known” investments. Here, a financial planner can be helpful in outlining a wider range of investment options which you might otherwise have missed.
According to psychologists, humans seek to avoid the feeling of regret as much as possible. This can have a powerful – and detrimental – effect on our investment decisions. In particular, it can lead us to hold onto a losing investment for longer than we should out of a desire to avoid feeling like we wasted time and money on it. Sometimes, however, an investment simply loses and it’s important to let it go. A financial adviser can help you discern this more objectively.
#10 Control illusion
We all like to feel like we are in control of our lives – and the world we inhabit. Yet we control far less than we typically believe. This naivety can lead investors to put more money into a risky investment than they really should – thinking that they know what is happening with the asset, and can navigate it perfectly with their decision-making. One way to protect yourself here is to diversify effectively and to limit your trading activity.
Conclusion & invitation
Are you interested in talking to a financial adviser about your pension and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
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