A cognitive bias refers to how our experiences and preferences distort our judgments and decisions. For example, when deciding whether to buy a new car, we might focus on the positive aspects of the vehicle (the safety features, the comfortable seats) and downplay the negative aspects (the high price tag, the small trunk). This tendency to over-emphasize the good and ignore the bad is known as confirmation bias, leading to poor decision-making. However, by being aware of our various biases, we might help to overcome them and make better financial decisions.
- Riding that high
When we succeed, especially when it comes to money, we may be blinded by that success. Don’t be tempted into thinking that the outcome was positive, so the decision must have been good, right? Wrong! What worked yesterday is never guaranteed to work tomorrow. The best way to begin understanding this relationship between your emotions and money management is by allowing for the passage of time. Allow yourself to come down from your emotional high and return to common sense and logic.
- Valuing facts we “see” and “feel” more than “abstract” facts
Good investing is based on conceptual and abstract truths that guide investors’ decisions. However, our personal experiences tend to be tangible and valued more simply because we can see and feel them.
- Valuing the latest information most
New information is crucial in the investment world – but it’s easy to get caught up in the latest news and forget about the market cycles that will eventually emerge. It’s important to stay mindful of the past and the present to make the best decisions for our future. If we’re not careful, we may miss significant opportunities (or warning signs) because we’re too focused on the present.
- Being overconfident
The more we invest, the more confident we become in our choices. When the market is booming, and most of our investments pan out, this reinforces our faith in ourselves, sometimes to a point where we might feel like we can’t make a wrong move. But this can be dangerous. Overconfidence can lead to poor decision-making and, ultimately, costly mistakes. So, even when things seem to be going well, it’s important to stay level-headed and humble in our approach to investing.
- The herd mentality
Fear of missing out (FOMO) is a real phenomenon in the investing world. When everyone else is buying, it can be tempting to jump on the bandwagon – even if it means paying too much. This herd mentality can also lead to panic selling when the market turns. And while social media makes it easy to see what everyone else is doing, that doesn’t mean it’s the best way to make investment decisions. Trying to time the market is a recipe for disaster, and following the herd won’t help you achieve your financial goals.
It can pay to take time to understand and refine your decision-making process. Don’t hesitate to share your thoughts with a financial professional who can provide you with a perspective of clarity.