With humans having over 34,000 unique emotions, it’s hardly surprising that they play a huge role in everything you do, from something as simple as choosing what to eat for dinner to something more complex like planning for the future.
Making investment decisions is no different. In fact, whether it’s becoming frustrated with a perceived lack of returns or having overconfidence due to previous success and using that to guide future decisions, emotions can very easily play a role in the management of your wealth.
As Dan Kemp from Morningstar Investment Management says: “Emotions play a huge role in financial planning. People often act against their long-term best interests.”
So, read on to discover five behavioural biases that you need to be aware of when investing and how working alongside a financial adviser can help you reduce the influence these biases can have on your investment decisions.
1. Confirmation bias
Confirmation bias is one of the most common emotional biases when it comes to investing. This type of emotional bias leads to investors making important decisions based on their pre-established assumptions, not factual evidence.
For instance, you may tend to look for information that supports and aligns with the beliefs you already hold about specific investment opportunities. While you might be drawn to information that validates your belief, you’d also be likely to ignore evidence that goes against it.
This can have a profound effect on your investing strategy, so speaking with a financial adviser could be a sensible option to help you avoid making decisions based on pre-established assumptions.
2. Overconfidence
Some investors can become overconfident following the success of a previous investment. They then believe that they know everything they need to when it comes to investing and base any future decisions on this recent “win”.
This is often the case when investors aren’t getting feedback or advice from an experienced financial adviser. In life, as well as in investments, people tend to protect their egos. So, it can be very easy for investors to get a false impression of success and then not seek any guidance or advice from professionals.
So, whether you’ve had success with previous investments or it’s the first time you are investing, it could be more beneficial to you to speak to a financial adviser rather than going it alone.
3. Loss aversion
Many investors consider avoiding loss as important as achieving gains. This is known as “loss aversion”.
Studies have found that humans feel the pain of loss more strongly than the pleasure of a gain. This can often skew thinking as, when investors make a gain, they may not give it much thought and move onto the next investment.
Meanwhile, when investors make a loss, they may take it personally as a serious failure of judgement and let it affect future decisions they make.
Attempting to avoid loss might mean you don’t take enough risk and, consequently, don’t achieve the growth you need to achieve your future goals. This is when working with a financial adviser could make a big difference to your thinking.
4. Herd mentality
Especially in times of market volatility or uncertainty, many investors seek to “follow the herd”. They will look at what others are doing and base their investment decisions on the crowd.
Known as the “herd instinct”, investors will join groups and follow the actions of others, often because they assume that the other individuals have already done their research.
One of the biggest examples of this was the dot-com bubble in the late 1990s. This period saw rapid technological advancement and the commercialisation of the internet led to huge growth.
Investors desperate to find returns freely invested in any company with a “.com” after its name and were far too willing to overlook traditional fundamentals and research. Even companies that hadn’t generated revenue or profits were going to market and seeing their stock prices rise hugely in one day.
As investment capital eventually began to dry up, some dot-com companies that had reached market capitalisations in the millions of pounds became worthless within a matter of months. Consequently, many people who had followed the crowd saw the value of their investment fall sharply.
5. Self-control bias
Some investors fail to act in pursuit of their long-term goals because of a lack of self-discipline. This is often the case in times of market volatility and uncertainty.
If investments don’t produce the results people expect, investors can often lack self-control to keep to their plan and may sell assets when the value falls. As investments are often held for a long timeframe, making regular alterations to your portfolio isn’t always a successful strategy.
To avoid the risk of self-control bias, having a financial plan focused on your goals could be beneficial. That’s when working with a financial adviser comes in, as they will help you devise a plan and stick to it.
Get in touch
If you’re looking to invest your wealth, you could be well served speaking with an experienced financial adviser.
We will act as a sounding board to help you avoid making emotion-led financial decisions and keep you on track to reach your long-term goals. Please email admin@stonegatewealth.co.uk or call 01785 876222.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Investments carry risk. The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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