People generally think of themselves as rational in their thinking, decisions, and actions. This is the goal. However, even the most intelligent and self-aware suffer from cognitive errors and emotional biases. It is the plight of the human condition. Biases affect us all and in all areas of life.
Recognizing and overcoming our own biases are difficult tasks, yet they are essential for personal growth and self-improvement. When it comes to investing, emotional and cognitive errors have monetary consequences that are difficult to quantify. Which of these biases are negatively impacting you?
Confirmation Bias leads us to discard valuable information for the sole reason that it does not support and confirm our existing beliefs. Having our beliefs challenged is not always easy, but our investment decisions should be based on facts and analysis–not the other way around.
FOMO: The Fear Of Missing Out on a good investment opportunity is a real struggle for some investors. It fuels bad decisions, leads to investing in assets that have peaked, and causes poor evaluation of risk. FOMO frequently burns investors who allow it to cloud their judgment.
Loss Aversion drives us to make decisions based disproportionately on our fear of loss. Statistically, investors feel the pain of loss twice as strongly as they feel the joy of gain. Consistently choosing to avoid risk will ensure you are missing out on many opportunities.
Recency Bias compels us to overvalue recent information. If the market goes up, recency bias will lead us to believe that growth will continue. The same is true for falling markets. Recency bias is much easier to recognize than it is to avoid.
Anchoring to data points, such as purchase price, often clouds judgment when making decisions about when to buy or sell an asset. Our entry point is an arbitrary price that has no impact on the future value of an investment. Anchoring to irrelevant or incomplete information is a harmful cognitive error committed by many investors.
One of the best ways to protect your portfolio from cognitive errors and emotional biases is to have a financial professional in your corner. Discuss your monetary ideas, financial options, and investment plan with your advisor before you make a final decision. Their expertise can help create peace of mind and guide you to the path of financial success.
