Common Investor Biases That Impact Investment Decisions

Are you aware that a particular area of study focuses on behavioural finance? The subject of behavioural finance allows us to identify human behaviour, response, and biases that affect our decision-making process. 

For example, behavioural finance concepts deal directly with our natural biases, leading us to illogical, irrational, and confusing decisions. Typically, behavioural finance deals with human behaviour affecting investments and finances. 

Prospect Theory

One example of behavioural finance is the concept of Prospect Theory. Expanding the concept of Prospect Theory shows that humans' emotional response is different when perceiving loss. Often, it contradicts our response when expecting gains. 

Prospect theory also shows that an investor may feel twice the pain of their losses compared to the good feelings that gains can bring. Some investors always worry about experiencing marginal changes in their wealth. Investors consume more time worrying about expected losses rather than focusing on the entire amount of their wealth. 

Worrying about losses in revenue can become problematic if the conventional investment platforms don't work well. Beyond conventional means of investment, there are alternative Investing platforms you can explore to see if they’re suitable for your current needs and risk appetite.

The typical investor's behaviour of preventing losses is a backward state of their thought process. Instead of focusing on their positive gains, investors are in danger of fixating themselves on the wrong issues. 

Typical Investment Biases to Avoid

Confirmation Bias

Remember the saying First Impressions Last? Surprisingly, it is a natural part of human behavior. People tend to look for patterns, signs, and information that can support an existing opinion or theory they have in mind. Confirmation bias also lets us resort to previous thoughts when we encounter something or someone new. It can affect investors, causing them to seek information reinforcing their investment ideas. 

Regret Aversion Bias

Also famous as Loss Aversion, regret aversion bias causes us to deny having regrets after performing an action that led to a negative outcome. Investors experiencing regret aversion bias tend to perform risky manoeuvres to avoid producing adverse effects. Regret aversion can also explain an investor's reluctance to let go of losing investments. 

Familiarity Bias

Humans always favour information, things, places, or people they already know. Familiarity bias represents investors who are unwilling to diversify investments. Investors might also become suddenly anxious when dealing with new information or diverse opportunities. The concept is similar to people who dislike leaving their comfort zones. 

Self-Attribution Bias

Investors suffering from self-attribution bias tend to attribute positive results to the actions they perform. They also might connect adverse outcomes to external reasons. People exhibit a self-attribution bias to boost their ego, push their agenda, or protect how they perceive themselves.

Disposition Effect Bias

Did you ever encounter an investor who quickly labels investments as winners or losers? If yes, they might be experiencing the disposition effect bias. The bias causes investors to sell a winning investment early. It can also lead investors to avoid selling and losing investments that do not yield positive outcomes.

Hindsight Bias

Any hindsight bias believes they can change future outcomes similar to their past experiences. People with hindsight bias fail to realize that there are some events that even the best forecasts cannot predict. 

Trend-Chasing Bias

Individuals with trend-chasing bias often perform the same actions they did in the past. People are prone to repeating the same methods that produced positive results. Aside from that, product issuers will increase their advertisements when performance levels are high. Contrary to popular belief, no one can perform the same manoeuvres and expect similar positive outcomes. 

Worry

Worrying is a natural and typical human emotion or response to various events. When people worry, they recreate past events and memories while imagining potential scenarios with varying outcomes. Worrying can also cause an investor to overthink an investment decision while causing analysis paralysis. It can prevent investors from making quick decisions. 

Conclusion

Understanding humans' different biases allow us to determine and prevent irrational decisions. Behavioral finance also plays a part while helping investors remove their emotional responses.