5 common behavioural investing biases
Achieving investment success requires a blend of disciplined portfolio construction and tempered investor behaviour.
By ATB Wealth 23 April 2019 1 min read
The Psychology of Money
In the Psychology of Money, Morgan Housel, partner at the Collaborative Fund and two-time winner of the Best in Business award from the Society of American Business Editors and Writers, writes; “The finance industry talks too much about what to do, and not enough about what happens in your head when you try to do it”. He’s highlighting the tendency people have to focus on the outcome of investing while paying little attention to how the peaks and valleys of investing can impact your emotions and decision-making ability.
Similarly, Jason Zweig, columnist for the Wall Street Journal, wrote a book called Your Brain on Money where he speaks to several studies, one of which illustrates how the brain activity of a person making money on their investments was indistinguishable from that of a person on cocaine or morphine. The euphoria of investment gains releases dopamines within the brain similar to those that are released when someone is high on narcotics.
Behavioural finance is the study of how human emotions affect the decisions we make about money. Human behavior is shaped by conscious and unconscious decisions which can be swayed by behavioural biases. Divided between cognitive and emotional, behavioral biases vary from person to person. A cognitive bias is the tendency to follow a personal rule of thumb (heuristic) rather then evaluate a situation objectively. Emotional biases are harder to manage, as they are simply taking action based on feelings, not facts.
Cognitive biases are thought patterns that cause us to deviate from rational thinking. Cognitive biases can be moderated through education and a little bit of self awareness. The tricky is that all humans are still prone to emotional biases which are not as easily moderated. This is because an emotional bias is generally irrational, and affects our short-term thinking and decision-making.
As we become aware of common biases, we can implement strategies to help guide us back to rational thinking and improve the decision-making process. In part three of our series, we will begin to outline the ways in which an individual can coexist with their biases. While it’s difficult to remove biases from our lives, there are ways to minimize their impact on our long-term thinking and decision-making.