In my 25 years of financial advisement, I’ve seen a lot of situations where people get in in the way of their own goals. How? Through their preconceived notions of investment. So today I’d like to share with you the top five investment biases that could be causing you to fall short of your financial goals.
Cognitive Bias. People with cognitive bias often share the beliefs of someone else due to their upbringing. For example, if you grew up in a household where your parents only invested in money markets or CDs, you might have a tendency to be just as conservative. On the other hand, if your parents liked to gamble, do you find yourself more willing to make high-stakes investments? Another’s footsteps may not lead down the path that works best for you. Let historical evidence and your individual goals dictate how you should invest.
Confirmation Bias. People with confirmation bias tend to interpret information according to preexisting beliefs. For example, if someone believes the stock market will be going down in the near future, they’ll tend to look for stories, articles, and interviews that confirm those beliefs. Everyone wants people on their side, so when an individual finds information that agrees with their personal ideas, it validates them.
Recency Bias. People with recency bias compare things to recent occurrences, often ignoring what has happened in the past or what could happen in the future. As an example, think back to when the dot-com bubble burst in 2000 causing the stock market to fall approximately 50%. Then, seven years later during the financial crisis, it fell another 50%. When 2014 rolled around, people thought the stock market would fall again because it had done so in the two previous seven-year cycles. They were looking at something that happened recently instead of at the big picture—what’s happened over the last 100 years, for example. It’s no different if something bad happens to us in life, we think about that and may even avoid situations where that same incident might happen again.
Home Bias. Home Bias can mean several things. First, it might be an employee of a company that tends to invest primarily in their company’s stock or stocks of similar companies. In other words, the investor is comfortable with that company and therefore thinks they have more knowledge and will be more successful sticking with just a few companies. Another example of home bias is where an investor will invest a large portion of their investments in their own country’s stock or bond market: Americans invest in American stocks, Europeans invest in European stocks, and so on.
Action Bias. People with action bias believe they are adding value when they are doing something. In other words, they may feel they have to trade frequently in order for their portfolio to grow. This can often happen during times where there is a lot of volatility in the stock market like the 4th quarter of 2018. It can serve as a defense mechanism. If I trade more, I can protect my portfolio. However, the most positive results tend to happen when we don’t interfere and instead let compounding take effect over the long term.
If you have any questions or need more information, feel free to reach out to me. I look forward to hearing from you soon.