By The motivating force behind the behavioral biases towards investment decisions.
Investment is usually believed to be a characteristic that acquires its application peculiar or specific event or occurrence through facts, analyses, and logical decisions. But there are many times when a sudden turning point brought about a shift in emotional-affective states and psychological mental biases, which might have led to inevitable irrational decision-making and also affected investment success in commercial enterprises. Behavioral biases are systematic patterns of deviation from rationality in judgment and decision-making. Recognition of these biases is essential for an improvement in investment strategies and making investments better aligned with achieving specific long-term financial goals.
Common Behavioral Biases Hitting Investor’s Minds
Overconfidence BiasMost common by far, many investors overestimate the amount they know, their skills, or their ability to accurately predict market movement. This overconfidence usually results in trading too much, excluding diversification, and taking more risk than warranted. This commonality has also been corroborated by research, finding that active traders tend to underperform the market because of it.
Investors do not exhibit the pleasure as a response to gains in equivalence to the pain often experienced with losses. Here, one might end up holding losing stocks just to wait for recovery because of a sense of loss, yet the consideration could have been based on cutting losses early and reallocating the money in better investment opportunities.
Confirmation BiasInvestors prefer to collect information that confirms what they already believe instead of contradictory data. This bias will usually lead an investor not to make sound decisions regarding investment since they will be looking at the information from a biased perspective. For instance, an investor who is bullish about a particular stock might only pay attention to good news concerning it while ignoring any bad signal.
Herd Mentality Most investors follow the crowd instead of conducting independent research. This is a classic case during the bull or bear market where people just buy or sell at that particular time because everyone else is doing it, resulting in an exaggerated market move.
Recency BiasAn undue importance is given to recent happenings and factors in making decisions. When the stock market is performing good dividends, investors may think that the stock will continue to rise forever, ignoring the track record of market cycles. When the market goes down, the investors panic and sell at the wrong time.
This bias refers to the fixation of investors at a certain price point-emphasis on the purchase price of a stock instead of judging it from its new value according to the latest information. For instance, an investor will hold on to a stock that has fallen below its purchase price but instead cloaked in a facade because there are better opportunities elsewhere.
The Consequences of Behavioral Biases
Behavioral biases affect many negative aspects of investment decision making.
Poor Portfolio Performance: Most of the time emotional decision-making leads one to horrific consequences, resulting in poor portfolio management and loss of opportunities.
Higher Risk-The increased exposure to risk that people incur comes from overconfidence and herd mentality.
Timelines Mistakes in the Market: Investors form market decisions based on current events by buying high and then selling low, culminating in big losses.
Less diversification: Some biases make investors limit themselves to a range of investments.