Investors have to constantly grapple with a ton of emotions when investing.
Let’s look at another three psychological biases that may screw up their decision-making process.
In case you missed it, you can read about the first nine HERE, HERE and HERE.
Recency bias
Recency bias refers to the tendency to recall or put more emphasis on recent events and observations.
People do so even if such events may have no strong bearing on the decision-making process.
The problem arises when people tend to place more weight on something that occurred recently due to ease of recall.
Applied to investing, this bias means that investors tend to forget events that happened in the distant past and place more importance on recent trends.
Recency bias explains why most investors are not prepared for a sharp downturn or bear market when a bull market has been raging for years.
Investors conveniently forget an old event (i.e. the bear market) but easily recall the recent one (i.e. of the market rising) and extrapolate it into the future.
This bias would exacerbate down and up moves during severe market shifts as investors are slow to react to new information and conditions.
Availability bias
Availability bias crops up when events or situations that come more readily to mind are perceived as being more representative than they are.
A common example of this in real life is the case of plane crashes.
News coverage tends to be heavy on such events because they are both tragic and uncommon.
The availability and widespread coverage make it seems as though plane crashes are more common than, say, car crashes, whereas the converse is true.
When investing, the ability to recall easily-available data (for example, from observable events) may make investors believe that such data is more representative than it truly is as the ease of recall is low.
Investment decisions should be made based on objective data gathered in a disciplined, structured manner.
They should not just be based on reliance upon easily-available or accessible resources.
Action bias
Action bias describes the case of the investor who cannot keep still.
This investor believes that he should always be “doing something”.
It may sound surprising, but one of the toughest things in the world is for investors to purchase shares and sit tight without doing anything.
The action bias arises because investors perceive that activity is necessary to generate good results.
However, research has shown time and again that frantic buying and selling incurs huge amounts of fees over time and erodes overall returns for investors.
In contrast, a buy-and-hold strategy not only incurs significantly fewer fees but also allows businesses time to grow their revenue and profits, thus earning them a higher share price over time.
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Disclosure: Royston Yang does not own any of the companies mentioned.
