Your Brain vs. Your Wallet: Common Investor Biases

When it comes to financial decisions, most of us think we act logically. We believe we analyze the facts and make the best choices for our future. But in reality, emotions and mental shortcuts often get in the way, especially with investing. This is where behavioral finance comes into play. 

Behavioral finance studies how our emotions and biases can lead to poor decisions, even when we have all the information we need. Let’s look at some of the most common biases that affect investors and how you can avoid them. 

1. Herd Mentality

The herd mentality is when we follow the crowd because it feels safer. When others are buying or selling a particular investment, we feel pressure to do the same. It’s easy to think that if everyone is doing it, it must be the right move. But often, following the crowd can lead to bad timing, such as buying when prices are high due to popularity or selling low out of fear. 

How to avoid it: Stick to your long-term plan and avoid chasing trends. What works for others may not be best for you. 

2. Anchoring Bias

Anchoring bias happens when we rely too heavily on the first piece of information we come across, or an “anchor,” when making decisions. For example, if you hear that a stock was once valued at $100 a share, you might expect it to eventually return to that level, even if the company’s situation has changed. 

This bias can cause investors to hold onto unrealistic expectations, making it harder to make objective decisions about the true value of an investment. 

How to avoid it: Be open to updating your views as new information comes in. Focus on current data and market trends rather than holding on to outdated or irrelevant reference points. 

3. Overconfidence Bias

Confidence can be beneficial, but overconfidence bias in investing occurs when we believe we know more than we do. This can lead to taking excessive risks or ignoring advice. Some overconfident investors even try to time the market, which is almost impossible to do consistently. 

How to avoid it: Stay humble and realistic about your abilities. Diversify your portfolio and rely on professional advice to minimize risks. 

4. Recency Bias

Recency bias occurs when we give too much importance to recent events, assuming they’ll continue. For example, after a market rise, we may believe the upward trend will last, or after a downturn, we may panic and sell, fearing further losses. Both reactions can lead to impulsive decisions based on short-term trends. 

How to avoid it: Focus on the bigger picture and avoid making decisions based on short-term events. Long-term investing requires patience and discipline. 

5. Confirmation Bias

Confirmation bias is when we only seek out information that supports our beliefs while ignoring anything that contradicts them. For example, if we believe a stock is a great investment, we might only pay attention to positive news while ignoring warning signs. This narrows our view and can lead to poor decisions. 

How to avoid it: Look at every investment from multiple angles. Seek out different opinions and be open to the possibility that you could be wrong. 

Final Thoughts

Being aware of these common biases is the first step toward becoming a more disciplined investor. While it’s impossible to eliminate emotions completely, recognizing how they influence your decisions can help you avoid costly mistakes. 

Remember, investing is a long-term journey. By keeping your emotions in check and sticking to your plan, you’ll be better prepared to navigate the ups and downs of the market. 

Sincerely,

Usman Afzal, CFA
Portfolio Manager
Alitis Investment Counsel