Over the last couple of months, we’ve been looking at what financial bias is and where it can come from. This month, we explore some of the most common types of financial bias. You might recognise some of the behaviours when you think back to previous decisions you’ve made.
So, here are seven types of financial bias that may affect your decision-making.
1. Self-attribution bias
When you see the results of stocks and shares, how do you assess their performance? Self-attribution bias means you tend to put successful investments down to your own judgement. In contrast, poor performance is chalked up as bad luck.
In terms of investing, self-attribution bias may lead to investors becoming overconfident in their abilities to spot a ‘winner’. Left unchecked, it can mean greater risks are taken than appropriate for the investor’s risk profile and goals because they believe they’ll be able to replicate the success, while the negative results are dismissed.
2. Confirmation bias
We all know that we should research investments before making a decision. However, even when we look at the information available, our bias can skew the conclusion we take away.
Confirmation bias refers to the tendency to seek out information that already supports the beliefs you have. It’s natural to make a snap decision about an investment opportunity. But information and evidence must be judged on its merits rather than whether it conforms to pre-existing beliefs.
3. Anchoring bias
Anchoring bias also relates to the way we process information when judging an investment. It refers to when an investor places to much focus on a single piece of data, anchoring their decisions to this.
For example, this may be how much share prices increased at a certain point in the past. It’s an approach that could misrepresent the value of investments and how they fit into your financial plan. In this instance, holding on to a past share price could mean overlooking the risk involved.
We’ve all heard the phrase ‘jumping on the bandwagon’ and it’s this approach that groupthink reflects. If you’ve ever invested or divested because others have done so, you might have fallen prey to groupthink.
Whether it’s peers in your social circle or the media, it can be easy to get swept up in how others are investing. Yet, while it may seem like everyone else is following a certain path, it often lacks context. Their goals and circumstances can be widely different from yours and, as a result, financial decisions that suit some may not be appropriate for you.
5. Loss aversion
Some of the above examples of financial bias can lead to investors taking too much risk. But taking too little risk can also be a result of financial bias. Loss aversion is one example of this. In this case, investors place a greater priority on not making losses rather than creating returns. It can lead to a more cautious approach than is appropriate once goals and circumstances are factored in.
Loss aversion can also lead to investors holding on to loss-making investments, even when a wider financial plan suggests it’s appropriate, as they hope to make their money back.
6. Disposition Effect bias
Do you label investments as ‘winners’ and ‘losers’? If so, disposition effect bias could be affecting you. It’s an outlook that can lead to a short-term focus on investing, for example, selling shares earlier than expected because the price has increased. It can also lead to investors holding on to loss-making stocks that no longer suit their profile and goals because they don’t want to ‘lose’.
It’s important that investments are considered with a ‘big picture’ approach and a long-term outlook. Thinking of individual investments as ‘winners’ and ‘losers’ can harm this.
7. Information bias
When you’re investing, you can be bombarded with different information. It can make it difficult to see the woods for the trees and select the information that should influence your financial decisions. This can be known as information bias.
For example, if short-term market movements are a core factor to investment decisions. It’s easy to see why this happens, as it’s often these gains and falls that make headlines. However, long-term prospects and opportunities are typically the areas you should be focusing on.
So, now we have a better understanding of how financial bias may be affecting our decisions, what can we do about it? Our final blog in the series will tackle this, keep an eye out for it next month.
Please note: 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.