Even the most perceptive investors, armed with years of market experience, can fall prey to mental biases that lead to poor investment decisions. The Hudson Companies team of experienced financial advisors uses facts and logic to guide our financial clients through their decisions, rather than emotion.
While it’s impossible to completely eliminate mental financial biases, our wealth and investment advisors explain to and help our clients identify and minimize that may lead to costly investment mistakes.
What are the most common financial biases that can influence an investment decision?
Behavioral psychologists Daniel Kahneman and Amos Tversky first explained the financial biases that inhibit an investor’s ability to make rational economic investment decisions.
The 5 Most Common Cognitive Biases That Influence Investment Decisions and How You Can Minimize Them
What are cognitive investing biases?
Cognitive investing biases involve information processing or memory errors compared to emotional investing biases that involve taking actions based on feelings rather than on facts.
1. Confirmation Bias
It is natural for financial investors to use information that supports their existing views and opinions.
That’s the reason why confirmation bias can lead financial investors to attach more emphasis to information that confirms their belief or supports the outcome they desire.Reducing diversification can have a negative effect and make investors overlook signs that it is time to make financial adjustments.Here is How You Can Minimize the Effect:
Gather up-to-date information from a variety of reputable financial sources. As an SEC registered investment advisor, my experienced financial planning team and I do exactly this for each of our investors. Our clients are fully informed of the pros and cons of their desired investments. They are given a more balanced view leading to better investment decisions.
2. Overconfidence Bias
A common behavioral bias in investing is overconfidence.
Overconfidence can cause investors to overestimate their judgement or the quality of their information. This can lead to “doubling down” on a losing investment instead of knowing when to cut losses. Also, they may under-react to important financial information about changing market conditions.
Here is How You Can Minimize the Effect:
The key for making better investment decisions is to develop and stick to a solid investment plan and make adjustments that are based on actual market conditions. Our team of experienced financial planners helps our clients to do exactly this every day.
3. Recency Bias
Investors who suffer from recency bias have a tendency to overvalue the most recent information over historical trends.
A recency bias is for example spurring investors into increased risk-taking after experiencing a favorable gain in their financial portfolio. Another one is when the investor experiences an isolated loss and decides not to make any portfolio adjustments for fear of further loss.
Here is How You Can Minimize the Effect:
Focus on the long-term performance of your portfolios. Review both historical and current performance. Our team of experienced financial planning and investment advisors sits together with our clients to review their portfolios to make better investment decisions for the long-term.
4. Loss Aversion Bias
Did you know that humans feel the pain of a loss approximately twice as much as they feel the pleasure of a similarly sized gain? This can often lead investors to focus on their investment declines more than gains. The investors then don’t properly allocate their assets, leading to the stagnation of the growth of their financial portfolios.
Here is How You Can Minimize the Effect:
Accept that losing money is an inevitable part of investing. Our team of experienced financial advisors works together with our clients to help them make better investment decisions and to create a financial plan with predetermined exit strategies.
5. Anchoring Bias
Anchoring bias is the tendency to “anchor” on the first piece of information received. Investors don’t evaluate the market as new information develops, and instead anchor their belief about the value of a stock at the initial trading price for example, and not on the current market conditions. This action can lead to unwise financial decisions that can damage their portfolio’s profitability.
Here is How You Can Minimize the Effect:
Assess investments based on current market value. Our team of experienced financial advisors and investment managers assesses our clients investments to help them make better long-term financial decisions for their portfolio.
Investing biases can lead people into making investment decisions for reasons other than factual market conditions, significantly diminishing their financial stability.
At Hudson Companies, and as an SEC registered investment advisor, my team and I have a fiduciary responsibility to help our clients avoid cognitive biases that can lead to flawed investment decisions.
For more information or a complimentary consultation contact the financial planning, wealth management and investment services team at Hudson Companies today.
Sources:
Parker, Tim. (2018, May 3). Behavioral Bias: Cognitive Versus Emotional Bias in Investing [Blog post] Retrieved from https://www.investopedia.com/articles/investing/051613/behavioral-bias-cognitive-vs-emotional-bias-investing.asp
McKenna, Greg. (2014, Nov. 20) Trading Insider: 5 Cognitive Biases That Can Hold Traders Back [Blog post] retrieved from https://www.businessinsider.com.au/trading-insider-5-cognitive-biases-that-can-hold-traders-back-2014-11
Lazaroff, Peter (2016, April 1) 5 Biases that Hurt Investor Returns [Blogpost] Retrieved from https://www.forbes.com/sites/peterlazaroff/2016/04/01/5-biases-that-hurt-investor-returns/
DesignHacks.co (2017, August). Cognitive Bias Codex [Infographic]. Retrieved from http://www.visualcapitalist.com/wp-content/uploads/2017/09/cognitive-bias-infographic.html
