Friday, July 6, 2012

Does Investment Bias Hurt Your Investing?

Do you find it almost completely impossible to remove complex thoughts and emotions when choosing investments. If you do you are experiencing "investment bias".

Believe it or not there is a whole field of study called “behavioral finance” and it is devoted to understanding why people make their investment decisions. People who do this as their profession say that we all can't help but have biases effecting our investment decisions.

Does this mean we are forever stuck and handicapped by this bias? No, because when we understand how these biases work we can learnt o avoid them.

Here are a few of the worst biases that effect our decision making when picking and maintaining our investments:


Overconfidence.
Overconfidence fools investors into thinking they know the right times to buy and sell an investment. This behavior also known as market timing can be very expensive if you are wrong too many times. Not only will you be losing money on bad trades but you will be experiencing more investment fees and taxes.

Representativeness.
There is a bias called "representativeness". This behavior shows itself as making investment decisions based on preconceived notions or stereotypes.  If you link stocks to other investments because they are alike in some ways, this is representativeness. The hot stock or sector is another form of this. Basing your investment decisions on the hot tip or rumour just leads you to making mistakes. Having a plan of building a portfolio in a balanced way will avoid this. Having good diversification and setting up a group of stock or better yet index funds that force you to be diversified will help you be more successful in your investments.

Anchoring.
This is similar to the previous bias but this bias makes investors weigh decisions to much on past performance of a sector or stock. If you believe a stock is worth a certain price and it drops, your bias assumes the stock is undervalued. This bias based on your assumptions and having no basis in fact will hurt your investment performance.

Confirmation.
This bias occurs when an investor looks for reasons to back up a decision on an investment. Looking for reasons to back up an assumption is backwards. Trying to find proof for your assumption will kill a portfolio's performance. Again, here a bias that is an idea not based on facts. 

A way to overcome bias.


We are all prone to making assumptions and a bias that is not based on facts, but feelings. If you are aware you have a bias, then you can take steps to be on the look out for it in your investment style. All this bias is hard to stay aware of and one way to to avoid it is to seek out good investment advice with a certified financial planner. They will be able to guide you into making more informed decisions and less emotional ones.

2 comments:

  1. Emotion runs amuck in many peoples investment styles. It really shows when things are going in the drink.

    ReplyDelete
  2. I appreciate you for giving such an informative portal. I find your site very informative and interesting and I like it! Thank you very much

    ReplyDelete

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