Investment biases continued…
In our previous article, we referred to emotions having a significant impact on investment decisions and that in many instances, emotional decisions are detrimental to investment performance. We also said those wrong investment decisions are likely to be repeated. These decision-making errors are called investment biases, and we made a distinction between cognitive biases and emotional biases.
To recap, a cognitive bias is when you make incorrect decisions from certain situations or information provided to you. Some "cold" cognitive biases for example are if you ignore important information, or you decide based on irrelevant details, or you place the wrong weight on certain information when making a decision.
Emotional biases are where people make wrong decisions based on how something makes them feel. People feel uncomfortable, angry or scared and then make decisions based on these feelings instead of facts.
In this article, we'll expand on cognitive biases and highlight a couple of different types:
- The first is confirmation bias. Investors who exhibit this trait will only invest in something if it aligns with their own opinion or their research. If something falls outside of this framework, then you are less likely to invest in it. Such investors are often blind or deaf to any information that contradicts their opinion and remains anchored in their view. Take, for example, Bitcoin. Many people already have an idea about whether Bitcoin is good or bad and will not easily deviate from their belief. Any contrary information about Bitcoin that does not necessarily support their view will most likely be ignored.
- Another cognitive bias is the so-called "status-quo" bias. We tend to ignore anything that threatens our habits or our comfort zones. Many investors are comfortable with what they know. If they are for example accustomed to interest-bearing instruments that offer returns lower than inflation, they tend to stay with them regardless of the long term adverse impact on their portfolio's real value. Others, such as property investors, also tend to hold even if the sector gets expensive or high-risk.
- Another bias that we often talk about is the negativity bias. Such investors will always find a valid reason why it is unwise to invest in the market right now. They are usually well-informed investors but place more emphasis on bad news about the market than good news. Some argue that it's good risk management; however, experience shows that this type of fear, coupled with negativity, often hinders investors from entering the market and missing out on real growth in the long-term.
Be careful of these biases and should you recognize such behavior in your investment approach, it may be advisable to obtain expert assistance to help you address such potential adverse thinking. Next time, we'll look at other biases that prevent people from managing their investments optimally.
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