We all try our best when we invest.
We do our due diligence, keep up with the latest developments and manage our risks carefully.
But despite our best efforts, we can still make mistakes.
Bad habits and practices may continue to dog you even if you are an experienced investor.
It’s nothing to be ashamed of, though.
We are all human.
The very nature of investing involves large sums of money, thus triggering emotions of fear and greed.
These emotions may wreak havoc on our investment process and cause us to make silly unintended errors.
The first step to overcoming these bad habits is to understand them.
Being aware of what may trip you up puts you in a better position to avoid these mental shortcuts and stay focused.
Here are five biases and mental shortcuts that you should actively avoid during your investment journey.
1. Hindsight Bias
Hindsight bias makes you believe that you knew about the occurrence of an event even before it happened.
In other words, you “saw it coming”.
This bias may also involve investors thinking that they had known the outcome of an event where the effects could not have been reasonably foreseen.
The problem with hindsight bias is that it empowers investors to make predictions for future events, thinking that they have a special gift of prediction.
By erroneously assuming that they could predict events accurately, they set themselves up for potential failure by betting the ranch.
Getting rid of this habit is easy — keep a journal of all your investment decisions and thoughts at a specific point in time.
Three months later, revisit this journal to see if you had, indeed, accurately predicted the course of events.
There’s a high chance that most of these events could not have been predicted in advance.
2. Confirmation Bias
Confirmation bias is a mental shortcut that investors use to filter out information on their investments.
This bias is dangerous as you filter out all information that does not conform to your beliefs while retaining and remembering the information that does.
By doing so, you end up reinforcing your convictions while dispelling any information that contradicts your beliefs.
Confirmation bias causes investors to seek out information that supports their investment thesis while rejecting information that does not.
This bias makes it tough to assess if something is going wrong with the investment as the investor ends up actively avoiding all bad news associated with it.
Anchoring is a common practice whereby investors “anchor” themselves to a specific price point for a stock.
This anchor could either be their purchase price, a recent high or a new low.
The problem with anchoring is that the mind gets stuck to that price level that may not have any bearing on how the business is performing.
So, an investor who purchases shares at $1 and sees the share price plunge below that level will end up waiting for it to recover back to $1 before he sells.
Even though the underlying business may be worth substantially less than a dollar, he is not willing to part with his investment because of his anchor at the purchase price of $1.
Anchoring is responsible for making investors hold on to losers for longer than they should, in the hope of eventually breaking even.
They would do themselves a better favour by just selling the lemon of an investment and moving on to a more promising one.
4. Availability Bias
Availability bias deals with how information is obtained and applied to a specific topic of research.
There is a tendency to rely on information that is more readily available to justify conclusions to open-ended questions.
So, if something is more easily recalled, it is then deemed to be more important to the decision-making process.
The ease of recall should not be a factor in determining if a particular piece of information is either more, or less relevant.
By actively checking for this bias, we end up making decisions that are more logical and objective.
5. Illusion of Control
People who have the illusion of control believe that they have more control over random events than they do.
This illusion makes you blame yourself when things don’t go as planned, even though it could have been due to a random occurrence.
The belief can also cause stress if you start to question your ability or if you’ve done the right things.
With investing being a probabilistic exercise, there’s a lot that is not under our control.
Ridding yourself of this illusion will free your mind from stress and allow you to make better decisions that are not hampered by self-doubt.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.