One of the main features of investing is “making a decision”. This means you have to take decisions based on information regarding where, when, how much and for what time to invest. Often these decisions are based on what you think and your emotional response. This is called Behavioral Finance. The study has revealed Top 20 Behavioral Biases in Investing Decision Making, a person suffers while making a decision.
This article is a collection of 20 cognitive biases. Yes, 20 and there may be many more discovered or undiscovered. The aim is to identify and work on our weaknesses arising due to these behavioral biases.
So here is the list of 20 main Behavioral Biases that are known to me:
People are over-reliant on the first piece of information they get. For eg “A golden opportunity near upcoming airport”. The investor is more inclined because of the news that an airport is coming. When? Is it really proposed? Is it cleared by authorities? No consideration.
Choice- Supportive Bias
When you choose something, you tend to feel positive about it, even it has a flaw. You recommend it to your group and family just to prove how right you are.
It is a tendency to seek more and more information to proceed or reject a choice. You call up relevant or non-relevant people, discuss at length, use google to get the desired information. Too much information is also not necessary. Adequate information is enough to make financial decisions.
This bias means when you simply believe that something will have a certain effect and you make that effect because you believe so. You feel equity can only help you reach your goals. Now, this may be true but suddenly you forget other things and start taking interest in equities. You even buy it without knowing much. It is quite common in medicine. If you believe in some specific doctor, whatever medicine he gives you, you feel better.
Under this behavioral biases, one overestimates the importance of the available information. You feel this is the most critical information that you have received. You know how Waren Buffet made his wealth and he still has his fries & coke. So you start following his diet. That may not work for you here.
You see patterns in the random event which are not related. You combine them to support your thinking or action. For eg., There is a terrorist incident on the border and you connect it with defense stocks and take a large position.
This is a tendency when the decision maker willfully ignores the dangerous and related information to support his position. Like the name of the bird, it is hiding from the reality and not accepting anything against.
When you overvalue a new trend or an idea. You purposely ignore the limitations or shortcomings. You feel positives will be sufficient to run this idea. This is lacking the balanced approach. Remember the IT bubble of 2000-01.
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You assume the good qualities of an investment or an idea without having any information about it. You make your mind so positive that the new idea seems to be old and you look like an expert. If you are so positive already that investment becomes your weakness.
It is related to stereotyping but here we put our expectations on what we perceive. We mix our thinking with the information we receive and bend it as per our thinking.
Bandwagon Effect or Herd Mentality
You enter a meeting room with your own thoughts about an issue. But in the meeting you see majority supporting the opposite view. The company leader gives an effective talk and people are supporting him. This changes your thinking too. You go with the group because you think the majority cannot be wrong or standing with the majority is a comfortable position.
We tend to hear only things which confirm what our perception is. If I have made up my mind to invest in a certain company, I will hear only the positive things. I will switch TV channel when the expert puts the opposite view or talks about risk factors.
Your current success becomes deciding factor for all the future decisions. You earned a handsome return from a stock by fluke, now you feel the stock market is so easy to manipulate. You start day trading with large sums in that stock because you feel you know that stock.
The tendency to only use the latest information and ignoring the history is recency bias. This can widely be understood by the fact that many investors just invest in equity fund with one-year performance. They feel that winner today will always be a winner even though, the disclaimer says “past performance is not an indicator of future performance”.
You just take the positivity of a situation. Many people leave jobs and leap into being an entrepreneur just to be “their own boss”. You think that business is an easy thing as you have not heard any one complaining of freedom. There are many aspects to become a businessman and challenges too. But you ignore since no one talks about the hardship.
Blind Spot Bias
You feel you are perfect and above from all biases. A false feeling of being a balanced person is a bias in itself. There is nothing called a perfect person forever. Scopes to learn and relearn is always there and makes you a better decision maker.
It is opposite of recency bias. You tend to be in history and ignore the latest developments. The classic case is of Satyam when investors did not sell it for the previous glory. Many investors still hold delisted stocks. Many still invest in LIC endowment plans and Bank FD.
Some investors are so overconfident about their views regarding investment world. This makes them take greater risks. Very often the so called experts suffer from this bias. Their success or fan following goes into their head and they feel themselves a god of markets.
Here the investor focus on what he has heard or read about a concept. Many people refrain from equity because they have heard that it leads to bankruptcy and suicide incidents. They continue investments in debt or low yielding securities and blame the government.
Zero Risk Bias
Suppose you have 2 options to choose. One is to make 13%-18% returns in 15 years by investing in equity Mutual Fund. Not fixed but a healthy range. The second option is a bond for 15 years with a coupon of 9%. Many people will take the second option for their love of “Certainty”. Many investors want to know beforehand and fix what they will earn. They do not want to live in an uncertain world even though 9% is taxable and equity mutual fund returns are tax efficient.
Do you suffer and encountered any of these biases or their symptoms? Hopefully, now you will be more careful.
Share your views and make aware of these biases to your family and friends by sharing this article on social media.