How behavioural biases affect investors’ decisions

Investing can be an excellent way to grow and build generational wealth. But how you approach it and the opportunities you pursue or pass directly impact your success. And experts suggest that your emotions have a bigger impact on your approach and behaviours than you might think.

Behavioural biases impact many of our daily decisions, though we may not often notice them. That includes our financial decisions. Keep reading as we take a look at some of the common behavioural biases that could be affecting your investing decisions.

Acting too conservatively

One way you could be holding yourself back from success in your investments is by being too conservative. As humans, we all struggle to adjust to change, whether we readily recognize it or not. Investors, particularly those new to investing, may self-justify their conservative behaviours as being safe. However, investing comes with inherent risks. Without accepting these risks, the opportunity for growth and success is limited.

A conservative approach can be attributed to cultural tendencies. Some cultures have a set-in-stone approach to dealing with money. That may lead many to choose the “safe” investment avenues or instruments, even if riskier ones are more likely to lead to greater returns.

Sometimes, acting too conservatively can also impact an investor’s decisions after they’ve already invested. For example, a conservative investor may find themselves with an insurance product with low coverage and high fees but may not exit the investment for the fear of losses. At times, such losses/penalties can pale in comparison to the benefits they stand to gain in the long run through the procurement of a better coverage plan from a different service provider. But individuals with a conservative approach may struggle to see this and prefer to stick with what they view as a “safe” investment.

Being overconfident

While some investors find themselves acting too conservatively and holding themselves back from potentially great investments, others face the opposite problem: Acting with too much confidence, followed by bad investments. Overconfidence can occur as a result of cultural influences or individual personalities. Individuals who tend to be overly confident in their work or personal lives are likely to approach their investment decisions with the same conviction. As a result, they may make bad investments by overestimating their ability to make decisions or assuming that previous successes will continue in the future.

Individuals who love the excitement and quick bucks may make decisions hastily without considering all possible outcomes. In stock markets, such investors may choose volatile equities, making impulsive decisions — like a gambler who gets caught up in the excitement of the game and continues biting more than they can chew.

Making future decisions based on past failures

Overconfidence or conservatism can cause an investor to act irrationally or avoid investing out of fear of failure. However, both these mistakes can also be the result of investors making their decisions based on previous experiences.

Research shows that many investors tend to rely too heavily on past failures or successes when making future investment decisions. Investments that should be treated as exclusive decisions end up being influenced by unrelated events. For instance, an individual may have had success putting a lot of money into a risky investment in the past. They are focused on this previous success and, as a result, make a risky investment that they might have otherwise avoided.

In the same way, if an investor previously lost money on a certain type of investment, they may avoid investing entirely in the future out of fear of another failure. Regret is a powerful emotion. If an investor feels regret over a previous investment, it can be difficult to overcome or ignore it while making future decisions.

Following the herd

The internet and investment apps have allowed individuals with little to no experience with investing to get started with stock trading. It has also led some novice investors to base their decisions on what’s popular or trending at any given time. Whether that means investing in a new cryptocurrency or purchasing stocks based on a rumour about future growth, the “bandwagon” approach to investing is risky. But following the herd is a human instinct — a need to belong or a feeling that if everyone is doing something, it must be right. It can be difficult to break this bias.

Overcoming behavioural biases

It’s hard to fully escape from the clutches of behavioural bias. Whether your culture urges you to be conservative, whether those around you are buying a certain stock and you’re tempted to join in, or whether previous wins have you feeling a little too overconfident, these biases can lead you to make poor financial decisions.

To overcome these and other common behavioural biases, it’s important to first recognize their existence. When you feel an impulse to make an investment or buy/sell/hold a stock, ask yourself why you’re making that decision. If the answer isn’t based on research, fact, or advice from a trusted expert, your decision is likely a result of a bias. To know more about such biases and how to address them, please drop a mail at info@cfsgroup.com.