Although we’d like to think that we are rational beings, many of our decisions are usually made with a veil of psychological bias. Here are 6 of them that you should take note of.
Anchoring
As the saying goes; “first impressions count.”
And that is very true. People tend to be over-reliant on their first impressions, even when they are subsequently exposed to evidence that they have been wrong. For instance, once you believe a certain business is successful, you may be inclined to believe that its stocks are an excellent investment.
That is also why many people invest in blue chip stocks without doing much research.
The best way to avoid this trap is to always keep an open mind when it comes to taking such important decisions.
Or, flip your stock picking process around by looking first at a company’s financial figures before you look at its name.
We do just that in our Conservative Net Asset Value (CNAV) strategy. Learn how you can do this at the Value Investing Mastery Course.
Confirmation Bias
Linked to Anchoring, confirmation bias results in investors looking for confirmation to back their unconscious decisions.
For example, an investor who is already interested to invest in say Starbucks would search for reasons to confirm that his decision to invest in it is correct. Instead of objectively evaluating a company, he would be more inclined to find positive reasons to invest and shun the negative reasons.
You can avoid this like how you would avoid to ‘anchoring’.
Relativity Bias
When we compare, we are vulnerable to relativity bias.
When compared an investment may appear cost-effective and safe. However, when looking at its numbers, you may find another story.
Always take an in-depth look at a stock’s financial figures before you make an investment, even when it sounds like a great investment when compared to its peers.
Situational Blindness
People who are in a bad situation tend to have a hard time in finding the exit. They tend to postpone the decision to accept their losses.
Hence, they tend to wait until nothing can be done to reduce the loss.
Set stringent cut loss rules when you invest, and stick to those rules.
Sunk Cost Fallacy
Admitting that you are wrong and accepting losses are difficult processes.
When you focus on the losses, you make decisions based on these past losses that could potentially affect your future returns.
Many investors also hang on to bad investments, even though they know that they should be cutting loss and moving on to better opportunities in the market.
Always treat a new investment decision as a separate scenario.
Superiority Bias
Many investors believe they can do much better than the market and even the experts in finance and investments. Even if you have a high level of education or a great IQ, you shouldn’t assume you know better than everyone else. By refusing to seek for competent advice, you risk to lose all your money.
There are many investors who have lost millions, simply because they thought they were smarter than all other players on the market. This is just one recent example: 20 say they lost $1m in investment scam
Conclusion
We are vulnerable to many biases. This article only mentioned some of the most common ones. Even smart people may fall into some of these traps, as there are multiple reasons why their mind is going to determine them do foolish things.
Sometimes, its easier to just admit these biases and be aware of all these traps. Keep an open mind and be honest with yourself. You should also be realistic in regard to your abilities, and seek for competent advice instead of doing what you believe to be best.