Markets can be turbulent, and as investor, we all experience emotions that effect our decision making and lead to common biases of what should happen next. Investing biases are psychological factors that can lead investors to make irrational decisions, often resulting in poor investment outcomes. These biases can be dangerous for investors because they can lead to poor investment decisions based on faulty logic rather than sound investment principles. In this article, we will explore six common investing biases and illustrate an example of each.
- Anchoring Bias: Anchoring bias occurs when investors rely too heavily on one piece of information when making investment decisions. For example, an investor may anchor to a particular stock price or earnings report and refuse to adjust their investment strategy even when new information suggests a different course of action.
Example: An investor may anchor to a particular price at which they purchased a stock and hold onto it even when the stock’s fundamentals have changed significantly.
- Confirmation Bias: Confirmation bias occurs when investors seek out information that confirms their existing beliefs and ignore information that contradicts them. This can result in investors missing out on important information that could inform their investment decisions.
Example: An investor may only read news articles that support their belief that a particular stock is undervalued, ignoring negative news that suggests the stock is overvalued.
- Recency Bias: Recency bias occurs when investors give too much weight to recent events and ignore long-term trends. This can result in investors making short-term investment decisions that do not align with their long-term investment goals.
Example: An investor may focus too much on the recent performance of a particular stock and make an investment decision based on short-term trends, rather than considering the stock’s long-term potential.
- Herding Bias: Herding bias occurs when investors follow the crowd rather than making independent investment decisions. This can lead to investors making investment decisions based on popular trends rather than their own analysis of the investment opportunity.
Example: An investor may invest in a particular stock simply because it is popular among their peers or has been heavily promoted by the media, without conducting their own research on the stock’s potential.
- Ambiguity Bias: Ambiguity bias occurs when investors avoid making decisions when the outcome is uncertain or when they do not have complete information. This can result in missed investment opportunities or inaction when action is necessary.
Example: An investor may avoid investing in a new technology company because they do not understand the technology or because the company is in a new and uncertain market.
- Myopic Loss Aversion Bias: Myopic loss aversion bias occurs when investors focus too much on short-term losses and are unwilling to take on risk for long-term gains. This can result in investors missing out on high-growth investment opportunities or exiting investments prematurely.
Example: An investor may sell a stock at a loss to avoid further short-term losses, even if the stock has strong long-term growth potential.
Understanding and avoiding these common investing biases can help investors make more informed and rational investment decisions. Ways to avoid these pitfalls are education, objectivity, diversification, and a long-term perspective. By focusing on the right things, investors will perform better over time.
|Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser|
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.