What are some psychological biases in investment & how to overcome them?

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Equirus Wealth

10 Apr 2023 5 min read

Investment#Investment

If someone offers you Rs. 1000 for either buying a dress or investing the same money in the stock market, what would you prefer? Isn’t this question thought-provoking? Many might wonder why Rs. 1000? It is a small amount. But some of you may think even this small an amount can be invested and multiplied.

Investment psychology plays an important role when it comes to trading. The most crucial factor when it comes to accumulating a treasury is your attitude toward investing money. Sometimes you may regret not saving and investing enough money because the market is on an upward trend. You can avoid this regret if you understand the psychological biases and how to overcome them.

Find some parts of investment psychology explained in the article below.

Psychological biases in investment decision-making are any preconceived notions that you may have regarding trading practices and the market. These notions affect your investment style and the strategies that you choose.

List of top 5 common psychological biases in investment: Here are some of the common psychological biases in investment that most investors undergo:

1. Overconfidence Bias

This investment bias tends to give you a level of overconfidence concerning either your experience in trading or the source of information you receive for a particular trade.

Example: If you have prior experience trading in a particular stock, and the growth of that stock is stable for a certain period of time, you tend to assume that the growth rate will remain the same, and hence you allocate a larger part of your investment in the same. But, the next month, the growth rate can change, and this might disrupt your expectation of returns from the market.

Learning: For any information you receive, it is necessary to check the validity of the same. It is crucial to overcome this bias to avoid future losses.

2. Bandwagon Bias

This bias is also called the herd mentality bias. As an investor, if you blindly follow the trading tactics that most people use, you might end up in losses if the market does not end up on the predicted trend.

Example: If you do not understand a specific type of investment or do not identify with its philosophy, but still invest only because your friend or colleague is investing, then it is a Herd Mentality bias. This might be profitable, but it might not be aligned with your financial goals and asset allocation and might not be a prudent investment for you in the long run.

Learning: It is always recommended that you independently study the investment opportunity and then choose the one which meets your requirements.

3. Availability Bias

When you invest in the market as a newbie, you tend to invest in stocks that have been advertised very often. This is because you know that the stock is available, and you do not find any more information on any other stocks.

Example: Just because a particular investment is being advertised prominently does not mean you need to invest in the same. Each and every investment needs to be aligned with your ulterior goal of wealth creation and your future financial goals.

Learning: The accuracy of the information should be checked before investing in any stocks. You should not prefer investing based on only the availability of stocks.

4. Loss Aversion Bias

The fear of investing is a huge factor that leads to loss of income and earning of returns from the market.

Example: As nouveau investors, when you invest, especially in the equity market, there is a constant fear that you will lose out on money that is invested in the market. In his book, “The Intelligent Investor,” Benjamin Graham mentioned, “Successful investing is about managing risk, not avoiding it”.

Learning: Understand your need for investing and the goals associated with the same. Then you need to map your asset allocation with your risk profile before opting for your investments. Also, before investing, do thorough research about the products and the risks associated with the same and then make an informed decision. So, while investing in stocks, understanding the stock market and thoroughly researching the stocks and company is essential to eliminate the loss aversion bias. Instead of avoiding investing, research the stocks and the companies.

5. Confirmation Bias

In this type of bias, you, as an investor, are very confident about some information received through a source and tend to overlook any other changes or factors in the market. Example: If you hear unfavorable news about your favorite company, you might still want to retain the stocks thinking of this news as a temporary phenomenon.

Learning: This bias and a perceived notion about a particular investment result in significant losses during trading. Consider any information equally important and give attention to all details and even minute changes, if any. This way, you can avoid losses from this bias.

Conclusion

Though you may think of psychological biases as trivial challenges in your investing journey, they may result in big hurdles. These biases can be overcome and identified in the initial time frame and rectified to avoid future losses.

Even if you can’t avoid all the biases in your investment journey, make sure you identify them as early as possible. When you trade, there should be less emotion attached to stocks and more analysis and research on the same. Similarly, for all your investment decisions, thinking rationally and doing thorough research are essential before investing. Professional help is available for resolving such biases. Long-term investors can benefit the most if such biases are eradicated at the beginning.

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