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Everybody has some inherent biases, isn’t it? You may be biased towards a particular brand, someone else may emotionally lean towards a certain cuisine, and yet another person may have behavioural biases that influence their decisions. These biases influence different areas of your life, right from the small things like the foods you prefer and the colours you like, to the big things like the career you choose and the friends you keep.
Investments and finance are not immune to your biases either. Your inherent beliefs and perceptions drive how you invest your money. The flip side is that these biases can prevent you from making objective investment decisions. In the long run, this could prove to be a costly mistake.
Fortunately, there are some tried and tested ways to overcome or avoid these pitfalls. So, here is a closer look at the top 5 investor biases, and how you can steer clear of them.
1. Information bias
Do you seek out every little detail, every fact and figure before you decide on where to invest? If you said yes, you may have information bias. It is the tendency to absorb and evaluate all information that you can find, even if it may be irrelevant to the investment options you choose.
An example of information bias
Say you want to buy a Unit Linked Insurance Plan, and you start to do a bit of research on life insurance. Over the course of your research, if you spend more time researching unrelated things like motor insurance and cyber insurance, that’s information bias.
How to avoid information bias?
Have a strict procedure for data collection and analysis, and train yourself to focus only on relevant and essential information.
2. Confirmation bias
Find yourself only choosing the details and facts that confirm your own long-held beliefs? In that case, you’re suffering from confirmation bias. The downside to this is that you may ignore any pertinent facts that challenge your beliefs, and consequently, you may eliminate some crucial elements from the decision-making process.
An example of confirmation bias
Say you always assumed that a fixed deposit is not a good investment option. In that case, you may tend to overlook safe investments like this even when the markets are performing badly, or when fixed deposit rates are actually lucrative.
How to avoid confirmation bias?
Challenge your long-held beliefs and look for information that you would otherwise not pay attention to. If you find yourself ignoring something because of this bias, encourage yourself to look again.
3. Recency bias
Recency bias is when you tend to value the most recent information more than older news and facts. This may be useful in some cases, but sometimes, it is also important to look at historical data.
An example of recency bias
Say you want to invest in equity funds. You choose a fund based on its most recent performance, completely overlooking the way it has performed over the past six months or one year.
How to avoid recency bias?
Study market cycles, look at historical information and consciously work towards factoring in relevant past data. Seek the help of a professional if you need to.
4. Familiarity bias
Do you find yourself gravitating to the same few investment options each time you invest? This is a classic case of familiarity bias, and it is common among both beginners and seasoned investors.
An example of familiarity bias
Say you have always held the stocks of five companies you prefer to invest in. 10 to 15 years later, even when there are new players in the market who are fundamentally strong, you find yourself investing in the same stocks over and over again due to familiarity bias.
How to avoid familiarity bias?
The simplest way to overcome familiarity bias is to diversify your portfolio and include different investment options, thus reducing the overall portfolio risk.
5. Anchoring bias
When you find yourself relying heavily on just one piece or one source of information, that is a case of anchoring bias. In other words, you tend to anchor on to a particular logical detail and rely on that bit of information to make your investment decisions.
An example of anchoring bias
Say you are looking for a good equity stock to invest in. And you always take your pick based on the 52-week low and high. This essentially means you are anchored on this bit of information.
How to avoid anchoring bias?
The easiest way to avoid anchoring bias is to encourage yourself to look at other aspects pertinent to your investment decisions. Adopt a comprehensive, 360-degree view of the information needed to select your investment options.
Summing up
These biases, as you may have guessed, are everyday notions that make their way into how you manage your finances and invest your money. And the first step to overcome these biases is to be aware of them. So, before you invest in a scheme or an asset, analyse the reason behind that decision. If you can justify it objectively, congratulations! You’ve successfully overcome your biases, and that’s a key step to becoming a better investor.
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