Common Investment Biases You Should Avoid (2024)

What are Investment Biases?

As individuals, we all have certain biases and beliefs. They stem from different sources and profoundly impact how we think about things in our daily lives, including investments. While some notions, such as discipline and patience, help in the investing journey, certain biases can be Achilles’ heel for you.

These biases hamper your investments and prevent you from augmenting your riches. They act as a roadblock in attaining financial freedom and addressing life goals. Here are the four biases you should steer yourself away from.

Investment involves making sound financial decisions influenced by market performance and the human brain’s intricate functioning. Investment biases, often called psychological biases, help make investment decisions.

Forbes Advisor India has identified common investment biases investors should avoid and provides tips for better investment decisions.

Common Investment Biases

Recency Bias

Recent events severely influence our lives so much that we quickly forget the past. In this bias, we tend to give more importance to recent happenings over historical ones. Investors have often fallen for this bias, only to rule later.

This bias came to the fore in March 2020 when equity markets nosedived and were hit by uncertainties amid the coronavirus pandemic. Investors’ wealth made over time eroded in no time. However, this was not the first time that Indian equity markets had crashed. It happened during the 2008 financial crisis and the 1992 stock market scam, only to bounce back stronger.

Confirmation Bias

It refers to the human tendency to interpret things to confirm existing beliefs, and any notion that contradicts them is weeded out without a second thought. Those with this bias don’t want to take the stress that accompanies conflicting views.

With this bias in your mind, you will always feel you are in command of your financial decisions and can never go wrong. However, it’s not so. More often than not, this bias gives you a false sense of hope, and you may invest in an instrument with poor attributes.

Loss Aversion Bias

We all hate to lose, isn’t it? Regarding investments, the focus radically shifts towards avoiding losses more than making gains. In the process, they lose out on chances that can augment their gains. In the long run, this can be detrimental to wealth creation.

While adopting risk-mitigating strategies is prudent, looking for opportunities to bolster gains is equally essential. Due to this bias, investors continue with loss-making investments to avoid the pain of making a loss. However, this drags overall returns and is a roadblock to achieving financial freedom.

Overconfidence Bias

Overconfidence is the tendency to become too confident, which can significantly affect investors’ financial decisions. Such a bias carries a high risk of predicting market movements, which can result in losses of large assets. Regarding investments, it’s vital to keep an open mind and proceed accordingly.

Herd Mentality Bias

Herd mentality bias is the tendency to be tempted into investing in a financial instrument after seeing peers doing it. On many occasions, investors chase the economic tools that others invest in, believing that such a move will help them build wealth and that they can not go wrong.

Anchoring Bias

Anchoring bias puts their thoughts primarily on first-hand information in the decision-making process. Such a bias may occur when Investors anchor high hopes on a particular investment’s performance based on its recent track record. Investors should make a rational judgment and assess an investment’s potential that aligns with their goals and risk appetite.

Sunk Cost Fallacy

Such bias causes investors to continue doubling down on a decision even in an unclear situation where the investment’s value is questionable. Sunk cost refers to continuously holding on to the investment until it recovers losses. Instead, investors can narrow the investment’s past expenditures and make a prudent investment decision.

Negativity Bias

The negativity bias, the tendency to give greater attention and weight to negative information or experiences, can influence investment decisions. Awareness of this bias can help avoid becoming overly pessimistic and missing out on potentially lucrative opportunities due to an overly pessimistic outlook.

How To Overcome Investment Biases?

By now, you must have realized that these biases pull you back and prevent you from leveraging your investments’ potential to the maximum. So, how do you overcome them? Let’s find out.

Be logical and analytical in your thinking

You can mitigate and overcome many of these biases by thinking logically and analytically. An analytical approach will help you go deep and understand the nitty-gritty, which is crucial for making the right investments. Do your research and make investments aligned with your goals and risk tolerance.

Understand your financial position

Just as we differ as individuals, so do our financial positions. Note that investments don’t follow a one-size-fits-all approach. So, you should not base your decisions on other’s financial position. Have a holistic view of your positioning and adopt a strategy accordingly.

Manage emotions

Investing emotionally can lead to flawed investment decisions and fall for any of the abovementioned biases. Hence, you must have a check on your emotions and adopt a rational approach. Weeding out emotions from investments can help you make decisions that can enhance your riches by a significant margin.

How To Make Better Investment Decisions?

Biases rob you of your ability to think logically and give you a false sense of overconfidence. That’s not all. You may end up sticking to a loss-making investment, hoping things will eventually turn. However, the damage has already been done when you realize your mistake. So, facing facts and molding your thought process is prudent.

Investors must decide by understanding the product structure and associated risks that align them with their goals and risk appetite. For instance, if you’re keen on investing in new fund offers (NFOs), understand the company’s fundamentals and analyze its long-term growth prospects. NFOs don’t have a track record, and investing in them just because others do it can cause wealth loss. Don’t follow the herd, but carve your own path.

Investors who remained invested during that challenging phase now have meaty gains. Certain events have sometimes forced investors to exit markets, fearing further loss. In the process, they converted notional losses into actual ones. Markets have scaled new highs and rewarded those who remained committed to their investments.

Hence, looking at the big picture and not banking on short-term trends is advisable. Whether you are investing in a stock or mutual fund, evaluating how long you must stay invested without giving in short-term trends is important.

Is it advisable to get help from financial advisors?

Professional help is always beneficial in every sphere of life, and investment is no different. If you find it challenging to overcome the biases yourself, seek help from a financial advisor. Financial advisors are qualified professionals who help you sort money matters, overcome preconceived notions and beliefs, and aid you in thinking logically.

Bottom Line

Biases stem from various sources, including the environment where we grow up and how we see people around us going about their investments. However, it’s essential to understand that wrong beliefs and notions can significantly hurt your finances and deprive you of wealth-creation opportunities.