When you make investment decisions, you know they should be based on data, logic, and careful analysis. Yet, the choices you make are often influenced by behavioural biases, and these psychological tendencies could even cloud how you view and manage existing investments.
Financial bias refers to the mental shortcuts or emotional tendencies that influence your decisions. In some circumstances, bias is positive and can help you make decisions quickly.
However, bias can also mean you overlook essential information or let emotions lead the way. When you’re investing, this could lead to you making decisions that aren’t right for you and may affect your long-term finances.
So, how do behavioural biases affect how you approach your existing investments? Here are five common types of bias you might recognise.
1. Status quo bias
Status quo bias is a tendency to stick to what you know. It’s easy to see why this happens; it can feel comforting to keep things as they are, including your investments.
Taking a long-term approach to your investments is a good thing. Indeed, making knee-jerk investment decisions based on the news or your emotions can be harmful. Yet, status quo bias could also negatively affect your investment performance.
For example, you might keep money in an underperforming investment fund simply because you’ve done so for the last 10 years. It’s a mindset that could mean you miss out on opportunities.
2. Endowment effect
If you value an investment more highly than the market price, you might be affected by the endowment effect. This is where owning something increases its value in your eyes.
Imagine if you purchased shares in a company five years ago. As you’ve watched the price of the shares rise and fall in response to market fluctuations, you’ve created a sense of connection to them. So, even if the company data suggests the long-term value of the shares has weakened, you might avoid selling them, because you believe they’ll rise despite the lack of evidence supporting this view.
3. Loss aversion
The theory of loss aversion suggests people feel the pain of losses more strongly than the pleasure of equivalent gains.
When you’re investing, this can mean you’re reluctant to sell assets at a loss, even if it makes sense as part of your strategy. As a result, you could hold on to assets when the money could be invested elsewhere in a way that aligns with your goals.
Loss aversion can also have the opposite effect. You might sell investments before you intended because they will deliver a gain that you’re eager to claim. While the value of your assets would still grow if you did this, you’d potentially miss out on long-term returns.
4. Anchoring
Anchoring is when you tie the value of an asset to a particular reference point, such as a past share price. It could mean you have a skewed view of the investment because you’re not considering the latest information.
For example, if you purchase shares for ÂŁ100, you may continue to view this as their value even though market conditions and company performance have changed since then. Again, this bias could lead you to hold on to underperforming assets for longer.
5. Confirmation bias
When you’re searching for information about a company’s performance, do you seek data that supports your already established view? If you do, you’re not alone. Many people are affected by confirmation bias and will ignore evidence that contradicts their opinion.
This can make it difficult to assess your investments objectively, as you’re only paying attention to some of the information available.
A financial planner could help you view your investments objectively
If bias affects how you approach investments, whether existing holdings or new opportunities, working with a professional could help you view your finances more objectively. Removing bias and emotions could lead to better decisions and outcomes that reflect your goals. Please contact us to arrange a meeting.
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.