8 Investment Biases That May Be Ruining Your Portfolio
Investment biases refer to the cognitive and emotional factors that can influence decision-making regarding investing. These biases can lead to poor investment decisions and negatively impact the performance of an investment portfolio. Understanding and awareness of these biases can help investors make better, more rational investing decisions.
1. Anchoring bias: This bias refers to the tendency to rely too heavily on a previous reference point when evaluating investments, such as an initial price or past performance. For example, an investor may be unwilling to sell a stock they purchased at a high price, even if it has significantly dropped in value because they are anchored to the initial purchase price.
2. Confirmation bias: This bias refers to the tendency to seek and interpret information confirming pre-existing beliefs about an investment. For example, investors may conduct research and only consider data reaffirming their belief that a particular stock is undervalued, ignoring contradictory information which shows it is not.
3. Representativeness bias: This bias refers to the tendency to evaluate an investment based on superficial or irrelevant characteristics rather than objective data. For example, an investor may be influenced by the fact that a company's CEO is charismatic and well-liked rather than focusing on the company's financial performance and potential for growth.
4. Herding bias: This bias refers to the tendency to follow the investment decisions of others rather than conducting independent research. For example, an investor may invest in a stock because they see that it is popular among other investors without conducting any research on the company themselves.
5. Overconfidence bias: This bias refers to the tendency to overestimate one's ability to predict the future performance of an investment. For example, an investor may be overly confident in their ability to time the market and make profitable trades, despite evidence that market timing is difficult and often unsuccessful.
6. Recency bias: This bias refers to the tendency to evaluate an investment based on the most recent or readily available information rather than a comprehensive analysis. For example, an investor may be influenced by recent news articles about a company rather than looking at the company's financials and long-term performance.
7. Mental accounting bias: This bias refers to the tendency to treat different investments differently, based on arbitrary or irrelevant characteristics, rather than evaluating them on their own merits. For example, an investor may have a different risk tolerance for an investment in their brokerage account versus their retirement account, even though the investments are identical.
8. Loss aversion bias: This bias refers to avoiding taking action to realize losses in an investment, even when it is in one's best interest. For example, an investor may hold onto a losing stock for too long, hoping for a rebound rather than cutting their losses.
Conclusion
It's important to remember that these biases are normal, and everyone is subject to them. However, by being aware of these biases, investors can take steps to counteract them and make more informed, rational investment decisions. Seeking professional advice from an object fee-only financial advisor, diversifying your portfolio, and regularly reviewing your investments are ways to help mitigate these biases’ effect on your portfolio.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.