Outsmart your biases: using investor psychology to your advantage
Written on the 2 November 2020 by Arrow
When it comes to decision making, we don't always get it right. It is human nature to fall for several behavioural traps when making everyday decisions and also when trying to predict the future. Even the smartest people can succumb to their own biases when forming judgements and making choices.
While it's unrealistic to expect to never again make a bad decision, we can of course recognise and anticipate possible biases so we can make informed decisions. This knowledge helps us to better understand how our mind works so we can use this information to our advantage for our next financial decisions, investments and life choices.
Here are a few of the most common behavioural biases (and therefore traps) to be aware of and tips for how to overcome them.
Overcoming this bias requires confidence and pragmatism, as often the fear and expectation of loss is greater than the loss itself. It can help to lower the cost of failure (for example, if you are investing) and increase the likelihood of success to feel more assured when making decisions.
This type of bias is often linked to people with high self-evaluations, however anyone can fall into the trap of overconfidence. To avoid it, consider the consequences of the decision and explore all possibilities rather than just the best case scenario. Be open to feedback and advice from others to help balance overconfidence and to give you more options to consider.
It is easy to get swept along with group consensus but there are ways you can minimise groupthink. Encouraging conversation and debate allows differing ideas and opinions to be considered in a group scenario this enables everyone to have their voices heard.
Even when making a decision by yourself you can still be swayed by the opinions of others, so don't let these overpower your instincts. Think critically and have confidence in your own analysis.
The primacy/recency effect
Awareness of this effect can help you understand why you're likely not using all information presented in your decision making, but only the first and last messages. Keep a record of all information to get a more accurate picture of the situation. It also helps to do your research so you won't just be influenced by the message from one source either.
These are just some of the biases that impact our decision making, from the day-to-day to the bigger life decisions. Having a trusted adviser in your corner can help improve your financial decision making, by providing market research together with considered advice through an external, unemotional lens. In fact recent findings from Russell Investments found one significant benefit of an advisers is they prevent clients from making silly behavioural mistakes.i
We can offer guidance to help you overcome your biases and make better choices, so don't hesitate to get in touch today.