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Behavioural finance: 6 unexpected ways bias could affect your financial decisionsPublished: November 3, 2022 by Jennifer Armstrong
How much does bias affect your financial decisions? While you may try to make decisions based on facts, it can be much easier than you think to overlook when your decisions are being influenced by emotions or bias.
Last month, you read about why bias occurs and how it can lead to “irrational” decisions through making shortcuts. Now, read on to discover six signs that bias could be affecting your financial decisions.
1. You hold on to certain information
When you make financial decisions, there may be a lot of information to process. So, you may focus on one piece of data. This is known as “anchoring bias” because your view is anchored to the information.
For example, when thinking about how valuable an investment is, you may anchor your view to a previous share price, even if further data means this is no longer accurate. It could mean you choose to hold on to an investment longer than is appropriate because you view it as being more valuable than it is.
This type of bias could mean you’re not looking at the full picture when you make financial decisions as you are blinded by a specific piece of information.
2. You’re too cautious
Often when you think about making investment mistakes, it’s taking too much risk that comes to mind. Yet, being too cautious when making financial decisions could be just as damaging.
Psychology theory suggests that you feel the pain of losses more than the joy of gains. So, it’s natural that you’d want to avoid a loss. That could mean you choose to take too little investment risk or not invest at all due to fear of potential losses.
However, being too cautious could erode value and affect your plans. It could mean you miss out on opportunities to grow your wealth even if they’re suitable for your risk profile and goals.
3. You’re overconfident
In contrast to being too cautious, overconfidence can be damaging too. It can mean you don’t manage risk properly and could lead to reckless financial decisions.
Overconfidence can mean you overestimate your abilities. This can often be seen in investing, where some people may believe they can time the market to maximise returns, despite markets being unpredictable.
Overconfident investors will often attribute “wins” to their skill and knowledge, but when they “lose” it’s blamed on things outside of their control. This mindset can lead to investors taking on even more risk that may not be right for them and a short-term outlook.
4. You follow the crowd
There’s something comforting about doing something that everyone else is. It can make you feel like you’ve made the “right” choice because everyone can’t be wrong, can they?
Herd mentality is another bias that can often be seen in investing. If all your colleagues are talking about an opportunity they believe will deliver returns, you can feel left out if you’re not part of it. You don’t have to know the people to be affected by herd mentality, reading the news or financial commentary can also encourage you to follow the crowd.
It’s a bias that can mean you make decisions that aren’t right for you.
5. You seek information that supports your views
It’s normal to seek out people that have like-minded views. It’s a bias that can affect how you seek and process information too.
Known as “confirmation bias”, some people will place a greater emphasis on information that reaffirms what they already believe. When making financial decisions, that could be that an investment is “bad” or “good”. It’s a process that can mean you discard valuable details without giving them the attention they deserve.
6. You give all information the same level of importance
How you process information can lead to bias. In the case of “information bias”, you give all information the same level of importance even though they could come from very different sources.
When you’re bombarded with information, it can be challenging to decide what to focus on. However, understanding that not all information is equally useful is important.
Knowing which information to discard and which to use to guide your decisions is difficult, but improving this process could help you make choices that are better for you.
Recognising bias can help you overcome it to make better financial decisions
Realising that bias could affect your financial decisions can mean you’re in a position to spot the signs and start to make better choices. Look out for our blog next month for tips on how to reduce the effects of bias.
If you have any questions about your financial plan or would like our support when making decisions, please contact us.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.