8 powerful investment biases that could damage your wealth

In 2010, the popular New York eatery Serendipity 3 introduced a hot dog called “Foot-Long Haute Dog”, which entered the Guinness Book of Records as the most expensive of all time.

Priced at nearly €60 at the time, dressings for the Haute Dog included medallions of duck liver and Dijon mustard with truffle shavings.

According to one marketing article though, the Haute Dog wasn’t necessarily introduced to be sold. It was a clever piece of marketing designed to manipulate one of the biases that we humans use to make decisions.

Here it was the “anchoring bias”, which is when you rely on a single piece of information to decide on something. That piece of information? When compared to a €60 Haute Dog, the €15.50 Cheeseburger seems like pretty good value!

With this in mind, you won’t be surprised to learn that our biases can let us down, and one time this could be true is when you’re dealing with your wealth and investments. Read on to discover eight investment biases and how they might prevent you from making the right decision.

Before we do, we need to look at the two different types of bias, which are:

Cognitive bias

This is when you decide using a pre-conceived idea or established concept, which could affect the way you interpret information and make a decision.

Emotional bias

This is where feelings are used to make a decision. For example, when you make a knee-jerk reaction to a situation you find uncomfortable.

4 cognitive biases to be wary of

Confirmation bias

As humans, we often pay more attention to information that supports our pre-conceived ideas. This might result in you ignoring information about your investments, no matter how logical it is, because it doesn’t match your beliefs. As a result, you may ignore warning signs about your current investment portfolio or opportunities regarding other funds that you should act on.

Herd mentality

This is where you could be influenced by the decisions friends, family, colleagues or the general masses make. Following others may cause you to invest in funds you later regret, or not disinvesting when you should. Be aware of what others are saying and doing, but always use your own research to decide.

Recency bias

Beware of deciding based on recent events. Investing in a company that’s performed well recently may result in you investing just as the value’s about to peak, or worse, about to fall in value.

Familiarity bias 

This is when you put too much trust in the familiar, including well-known investors, investment companies or celebrities. Concentrating on the familiar could result in you putting money into investments that you might normally avoid.

4 emotional biases to avoid

Loss aversion

As humans, we feel a greater sense of pain from loss than we do joy from a gain. This could result in a decision that’s only made to avoid the discomfort of a loss, which you later regret. For example, you might sell your investments when the market drops to eliminate the possibility of a further fall in value.

However, doing this could mean you cannot recover the loss and enjoy future potential growth should the investment start to grow in value at some point in the future.

Overconfidence

This could be dangerous if you’ve enjoyed success with previous investments. If you then become overconfident, you may ignore vital warning signs about your existing funds, meaning you hold on to them for longer than you should, and suffer greater losses as a result. Alternatively, you may not switch to another investment that could offer better returns.

Probability neglect

Humans often disregard probability when deciding in uncertain situations. This can be because you could use emotion and not facts in your decision-making process, and potentially underplay the positive and over-inflate the negative. For example, you could conclude your investments will never recover from a downturn.

Self-control bias

Delayed gratification is something many adults can struggle to master, as many instead opt for instant or short-term gratification. Self-control bias can prevent you from reaching your long-term financial goals because you may use money you should invest to pay for a holiday or upgrade your car instead.

A financial planner could help avoid these biases

Speaking to a professional who understands the world of finance and investing could help you side-step these biases by providing a second opinion. They could help you understand if you’re at risk of making a decision you later regret because one or more of these biases might be coming into play.

They will also be able to explain what’s happening with the markets and your investment, helping you understand your options and the potential consequences of any decision.

Get in touch

If you would like to discuss your wealth or investments with someone who could help you make a decision you’ll probably thank yourself for in years to come, please contact us. Simply email us at info@blackswancapital.eu, we’d be happy to talk.

Please note:

This article is for information only. Please do not act based on anything you might read in this article.

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.