Investors are routinely warned about allowing their emotions to influence their decisions. However, they are less routinely cautioned about their preconceptions and biases that may color their financial choices.
In a battle between the facts & biases, our biases may win. If we acknowledge this tendency, we may be able to avoid some unexamined choices when it comes to personal finance. You may benefit from recognizing blind spots and biases with investing when they arise. Here are some common examples of bias creeping into our financial lives.
Letting emotions run the show. An investor thinks, “I got a great return from that decision,” instead of thinking, “that was a good decision because ______.”
How many investment decisions do we make that have a predictable outcome? Hardly any. In retrospect, it is all too easy to focus on prize from a decision over the wisdom of the decision. This leads us to believe that the findings with the best outcomes were the best decisions, which is not necessarily true. Think of it like basketball, just because shot went in does not mean it was a “good shot”.
Valuing familiar facts over unfamiliar facts. Information that seems abstract may seem less valid or valuable than information that relates to personal experience. This is true when we consider different types of investments, the state of the markets, and the economy’s health.
Valuing the latest information most. In the investment world, the latest news is often more valuable than old news. But when the latest news is consistently good (or consistently bad), memories of previous market climate(s) may become too distant. If we are not careful, our minds may subconsciously dismiss the eventual emergence of the next bear (or bull) market.
Being overconfident. The more experienced we are at investing, the more confidence we have about our investment choices. When the market is going up, and a clear majority of our investment choices work out well, this reinforces our confidence. Sometimes to a point where we may start to feel we can do little wrong, thanks to the state of the market, our investing acumen, or both. This can be dangerous. The opposite can also affect you. If the market is going down that doesn’t necessarily mean that you are making bad choices. Sometimes the market just goes down.
The herd mentality. You know how this goes: if everyone is doing something, they must be doing it for sound and logical reasons. The herd mentality is what leads many investors to buy high (and sell low). It can also promote panic selling. The invention of social media hasn’t helped with this idea. Above all, it encourages market timing, and when investors try to time the market, they frequently realize subpar returns.
Sometimes, examining our preconceptions may help us as we invest. If you are having trouble identifying biases you may have, reach out to a trusted financial professional.