Everyone is affected by bias when they’re making decisions. However, while some choices will have little effect on your future, financial decisions could significantly affect your long-term security. When it comes to money, you ideally want to focus on logic and long-term goals rather than acting on biases.
Financial bias refers to the unconscious tendencies or emotions that can cloud logical decision-making about money.
While you might know that making investments or other financial decisions based on emotions is often a bad idea, one of the challenges is that it can be difficult to recognise when biases are influencing you. Indeed, you might believe you’re making a rational decision, but when you examine your motives, you realise emotions or social pressure are playing a role.
Being able to objectively look at what’s guiding your decisions could allow you to make the choices that are right for your long-term plans.
So, here are five signs that financial bias might be affecting your choices. Recognising them in your actions could give you a chance to review your decisions from a fresh perspective.
1. You feel the need to act urgently
If you feel like you need to react immediately to news or updates, emotions could be getting in the way of you making a logical decision.
For example, while investing can feel like you need to react immediately to secure the best returns, taking a long-term view is often a better approach for the average investor. Rushed decisions could mean investing in assets that don’t align with your financial goals or reacting based on only a portion of the information available.
Feeling the need to act urgently could be fuelled by fear – you might worry that if you don’t take immediate action, you’ll lose money or miss out on an opportunity – or other emotions.
If you find you’re frequently making reactive decisions, set a cooling-off period. Giving yourself 24 hours to think through the options could let your emotions settle and mean you can come back to the decision with a clear head.
2. You’re focused on short-term performance
How often do you check the performance of your investments?
While it’s natural to want to keep an eye on investment performance, especially during periods of volatility, it can lead to a short-term mindset. If you’re fixating on day-to-day changes in asset values, recency bias could be playing a role.
Recency bias is when you place too much weight on recent events. So, rather than looking at how your investments have performed over the last decade, you’re focused on the short-term market movements. It could lead to you making decisions based on short-term trends and potentially missing out on long-term gains.
You should invest with a long-term time frame, so zoom out when you’re reviewing performance to assess how your portfolio has fared over years, not weeks.
3. You’re distracted by what other people are doing
Going against the crowd can be scary in many situations, including when you’re making financial decisions. If you’re not following what everyone else is doing, it can feel like you must be making a mistake.
If you find yourself distracted by what others are doing, herd mentality could be affecting you.
Remember, even if a financial decision is right for your friend, it doesn’t automatically mean it’s a good idea for you as well. Your goals and financial circumstances could be very different and affect what’s right for each of you.
4. You ignore important market conditions
Being able to review information objectively can help you align decisions with your long-term goals. However, biases like overconfidence could mean you dismiss market conditions and instead rely on your instincts, even if evidence suggests your strategy might not be right for you or the current environment.
While it’s true that you shouldn’t let every headline dictate your decisions, overlooking data could be just as damaging. Regular financial reviews could help you strike the right balance and understand which information is relevant to your investment goals and time frame.
5. You want to “win” when investing
How investing is depicted in the media can make it seem like something you can win or lose at, and it can encourage a “go all in” mindset. That might lead to you investing a large portion of your wealth into a single opportunity or withdrawing all your investments to hold in cash during a downturn.
In reality, most investors benefit from a diversified portfolio that holds a range of assets and investments in different sectors and geographical locations. This means that when one area of your portfolio experiences a dip, it may be balanced by gains in another.
While that might not seem as exciting as putting all your money into a single investment opportunity in the hopes that it becomes the next technology giant, diversification can deliver more stable gains and be tailored to suit your risk profile.
Working with a financial planner could help you identify bias
It can be difficult to assess what’s guiding your own decisions, especially during emotional times. Working with a financial planner means you have someone who understands your situation to discuss your options with and counteract emotional reactions.
Please get in touch to arrange a meeting to talk to us about your financial plan and how to remain on track to reach your long-term goals.
Please note:
This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up, and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.