To make good investing decisions, you’ll need to digest quite a bit of information. However, the human brain can only process so much data at a given time.
No matter how interesting or important a topic is, you might end up not understanding a thing due to information overload.
To cope, you might find yourself taking mental shortcuts to make choices quickly. These quick decisions are often influenced by personal bias, which can sometimes do more harm than good.
Read on to know the common types of investor bias and what you can do to address them.
What is bias?
A bias is a tendency to accept or reject something or someone, often based on assumptions. Biases can be conscious or unconscious and they affect people’s actions and decisions.
They can cloud a person’s judgment and limit the ability to objectively consider facts and evidence. Biased thinking can keep you from making rational decisions, which can be costly especially when it comes to financial matters.
What are the common types of personal bias in investing?
There are many different of types of biases that can affect investors’ decision making. Here are a few common ones:
Herd mentality
Peer pressure can influence people’s actions even when investing. Herding happens when you invest in a product simply because everyone around you seems to be doing it.
Confirmation
Confirmation bias is the tendency to accept information that aligns with what you already believe in. It also means rejecting evidence that contradicts your beliefs.
Loss aversion
In investing, loss aversion is when the pain of losing money is felt more intensely than the joy of earning the same amount. An extreme fear of loss can lead people to become too cautious when investing or to avoid it altogether.
Recency
This is the tendency for people to place more importance on new information or recent events instead of taking a long-term view.
One example of recency bias is when people invest in an asset just because it’s currently performing well, believing the “winning streak” will continue.
Anchoring
This is when first impressions last. You have anchoring bias if you rely on the first piece of information you receive about a topic.
Let's say you read an article that tells you to buy shares of a certain company’s stock. With anchoring bias, you might believe that article and ignore another source that says it’s a bad investment.
Familiarity
This involves sticking only to what you’re familiar with and not wanting to go out of your comfort zone. One example is investing only in a certain product – since it’s what you know – and avoiding assets that aren’t as familiar, even if they might actually be a good fit for you.
Some types of biases can have a bigger effect on you than others. This is because of your unique personality, values, and the information available to you.
Addressing your biases
It takes a lot of time and effort to make smart investing decisions. That’s why it can be tempting to take shortcuts by relying on a hunch or gut feel, which are often the result of personal bias.
While biases aren’t always negative, they can still affect how you think to a certain degree. Here are some ways you can address biased thinking:
- Do your research by using trusted sources
- Study all sides, including information that may be at odds with your assumptions
- Take time to make a rational decision
- Follow a sound investment strategy
- Consult experts for a second or even a third opinion
It also helps to keep your goal in mind. Whether you’re investing for a comfortable future or for a major purchase, it’s good to remember what’s at stake.
This can keep you from making quick judgments and push you to be more careful and logical with your decisions.
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