Four cognitive biases that can have an impact on your investment portfolio
Summary: It is not just your emotions that can influence investment activity, but innate biases that you may not realise you have. Biases can affect investments as they are often predetermined. They may also result in investors acting on a gut feeling rather than conducting rational analysis.
Gambler’s FallacyGambler’s fallacy is a bias where an individual believes the likelihood of something happening becomes higher or lower as an event or process is repeated. Let’s say an investor continues to increase their position in a stock despite witnessing repeated and mounting losses. This investor believes that the stock price will most likely change direction as losses continue to increase, but this mentality is incorrect. Each event is independent, and there is no correlation between past and present occurrences.
Confirmation BiasConfirmation bias is another common cognitive bias where you look for, believe, or favour information that supports/confirms your pre-formulated values or beliefs. Investors may also intentionally ignore information that contradicts these values and beliefs. For example, if you are steadfast in owning shares of a company, such as Tesla, Amazon, or Alphabet, and you may ignore unfavourable news about that particular company’s quarterly reports, you are committing a form of confirmation bias.
Representative BiasRepeating investments for no other reason than because they previously brought you success, is an example of representative bias. Another example is if you believe an investment is good or bad based on a company's past performances. Let’s say a business you have invested in releases a strong earnings report. You may assume that the next earnings report will be just as strong, but, as you now know through the gambler’s fallacy, past events don’t change the likelihood that certain events will occur in the future.
Status Quo BiasLike representative bias, status quo bias means you are conducting old investments or using old strategies rather than exploring new options. If you are using old methods to execute new investments, you may be blinded by your perceptions and cannot recognise that the market has changed and your old strategies are not viable.
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