Investing is a rewarding but challenging part of modern life. Investors have to navigate a wealth of false information, relevant facts, and trends that may or may not point to stock price development. They also have to contend with a number of biases that tend to hold them back as they choose between stocks, bonds, and other investment vehicles. Here are three common biases and a few ways to avoid them.
This bias involves the desire for people to seek out information that will confirm their original beliefs. People have the inherent belief in their own reasoning and investment skills. Their beliefs will then guide future decisions and research. These people need to be more careful about how they research and make decisions. Checking their own decisions with those of a stock broker or certified financial planner will help them break the bubble of confirmation bias and make them smarter, more flexible investors.
This bias refers to the fear people have of repeating decisions that did not work for them in the past. It is particularly relevant for investors who lose a massive amount of money in a stock market crash or correction. These investors vividly remember their losses and are sometimes reluctant to make the same decisions again. However, this regret aversion can turn from mere prudence into a bias that holds an investor back. While specific stocks may lose all of their value, the market itself has always rebounded from its losses. This potential for recovery means that investors should follow a plan and reevaluate their holdings once a year no matter how much they have lost. They do not need to worry about the potential for the next crash. Instead, they need to worry about how much money they will lose if they continue their trend of regret aversion.
Hot Hand Fallacy:
This fallacy is the belief that prior success guarantees future results. Individuals falling for this fallacy believe that they have a “hot hand” because their earlier predictions had been correct. This fallacy leads investors to place an undue amount of trust into their decision-making and that of others such as mutual fund investors. In fact, past performance is not indicative of future results. Past successes may be the product of either sound investing or sheer luck. They should not dissuade an individual from seeking out more information or other opinions that help them craft their investing approach.
Traders have to deal with a multitude of different biases on a daily basis. They may seem impossible to manage and handle effectively. However, research and strategies are critical for any successful investor. Investors must be able to pick a well-researched investing approach and then stick with that approach for a pre-determined period of time. Investing the right way helps minimize losses or missed opportunities that come from trusting in biases.
Yorkville Advisors are a global investment provider.