One thing that keeps people back from building wealth are psychological biases. And this is purely because we humans are wired that way. The action that you take on specific triggers is regarded as biases. The fact is that we all have biases that influence the way we perceive the world, people, opportunities and, of course, our money. As humans, we are prone to a wide range of emotional biases that can cause us to think and behave irrationally, leading to flawed decisions and impacting our financial success.
Many of these biases are mental shortcuts that we use when making complicated decisions. It clouds our judgments and causes us to make mistakes with our money.
But once you are aware of them and know how to go about each one of them, you keep them in check as well as financial errors.
BOOM Money tells you a list of 10 of these mental biases
- Loss aversion: This bias causes people to prefer avoiding losses to making gains. For instance, one investor may be worried that his losing stocks will rebound, so he avoids selling them. So even if the investment is causing him losses, he refuses to sell it in the hope that he will make his money back.
- Confirmation bias: This is a natural human tendency to look for information that confirms our beliefs or cherry-picking. Most investors are overconfident that the data they receive reinforces the decisions they have made. And this can result in overconfidence or a false sense that nothing will go wrong.
- Information bias: This is a human tendency that deeply analyses information even when it does not help in resolving a problem or an issue. For example, suppose you are concerned about the mid-term prospects of your investment. In that case, you may be obsessed with the daily share price of market movements that typically contain no relevant information to you. This can cause you to sell sound investments if you notice that the share prices fall.
- Anchoring bias: This bias takes place when investors purchase or sell based on arbitrary price levels or purchase points.
- Status quo bias: This is the tendency of preferring things to stay the same. You may choose to keep things the way they are because it's always been that way, and this can cause you to remain invested in an asset that may no longer be appropriate for your portfolio.
- Endowment bias: If you consider an investment you already own as more valuable than similar other assets that you don't, it's regarded as an endowment effect or bias. For example, you may have inherited property or perhaps invested in property that has risen in value. This asset takes up a considerable portion of your portfolio, bringing you significant risk. But since you're emotionally invested in it, you may find it challenging to sell it.
- Sunk cost fallacy: This takes place when investors continue investing money in a losing project. For example, you may be spending thousands of rupees on a vintage bike that keeps breaking down. You're not prepared to purchase a new car or another to be them because of the amount you've already put into the vintage bike.
- Bandwagon effect or herd mentality: This is a typical mentality that new investors often fall prey to. For example, there's sudden information regarding a new stock or a hot tip. Everyone rushes to buy that stock, even if it may not be a good fit into their portfolio.
- Disposition effect bias: This is the tendency of labeling investments and assets as winners or losers. This bias could lead you to stick to an investment that no longer brings you any revenue or sell a good investment too early to make up for prior losses.
- Self-attribution bias: This bias tends to attribute successful outcomes of their actions and bad results to external factors. It can cause investors to become overconfident.
How To Avoid These Biases?
The first step to overcoming biases is to realize and not ignore that we rely on biases to make investment decisions. There is no doubt that it can be nearly impossible for us to be completely unbiased. But we can cut down the impact when we identify the bias that's affecting us. Thinking calmly, tempering our emotions and outsmarting our brains can help achieve better outcomes.
- Loss aversion: If you can accept what you have, express gratitude and eliminate the fear of losing, you could set yourself up for more success than your fear of failure. Think and act long-term rather than short-term; this thought process can help you perceive that the asset you hold onto is valuable.
- Confirmation bias: Look for contrary opinions, even of those that may seem uncomfortable to you. Ensure that you do not rely on just one information source to make opinions about an asset. Your biggest ally in overcoming all kinds of biases, especially confirmation bias, is knowledge and the correct information.
- Anchoring bias: Taking a practical approach to your money and being objective about your investments can prevent you from anchors that could impact your financial plan or investment pattern. Practising critical thinking can be an essential aspect in avoiding anchoring bias.
- Status quo bias: In many cases, the status quo is an emotional bias that can be too deep-rooted. You can overcome this bias when evaluating your investments and purchases on a periodic basis.
- Endowment bias: When purchasing assets, beware of sales tactics that try to bond you with assets or investments. When trying to sell an investment, keep in mind its opportunity costs. It can be better to sell an asset for its work rather than not to sell it at all. Also, remember to raise your prices on market value.
- Sunk cost fallacy: Do not dwell on bad investment decisions. Instead, remember the big picture and track your investments.
- Bandwagon effect or herd mentality: An excellent way to combat this bias is to make deliberate and opposite investment decisions against the majority. Also regarded as contrarian investing, it is a form of investing that goes against the consensus. But, remember to get absolute clarity on your decision after thorough due diligence.
- Disposition effect bias: There is a technique to overcome this effect — the pre-commitment technique. That means you need to place your winners within a specific period. When a profit-making investment or asset comes within your group, try pre-determining your investment horizon and only consider selling it after this time frame.
- Self-attribution bias: To be financially successful, you need emotional intelligence and the ability to self analyze. That means it is essential to know your strengths, acknowledge your weaknesses and grow with them. Doing so can enable you to understand the right strategies to use to become a better investor.
This story is a part of BOOM Money's series on personal finance