We wrote in October about “Staying out of your own way”, a piece that resonated with a lot of people in these volatile investment markets. In this article, we spoke about how managing our own behaviours is the single factor that will probably have the greatest impact on our investment success.
Now picking up that theme again and going a little deeper, we’re going to explore some of the main biases that unfortunately are in-built within us and that can really cloud our judgement when it comes to investment decisions. These biases regularly trip up even the most experienced investors.
Recency
Recency bias is a bias towards placing too much emphasis on recent events, as opposed to looking at a longer-term picture. An everyday example is when someone is asked to list their 10 favourite books or movies. What often happens is that the person will give far more weight to recent reading or viewing, as opposed to thinking through what their favourites really are.
This pops up a lot in investing where investors give far too much weight to recent events. An example is where a stock or even a market takes a short-term dip. Even if this is after a prolonged growth period, investors can often give too much weight to the recent dip, as opposed to considering the long-term trends.
Anchoring
Anchoring bias is where you base a decision on a past piece of information, even though the old information may have become irrelevant at this stage. A good example of this in relation to investing is when we see people anchoring investment decisions to the price paid for an asset. Thy might say that they bought a share at €10, so they won’t sell it for less than that. However they are forgetting that the market doesn’t care what you paid for the share – this is irrelevant to the future performance of that share. Instead investors should lift that anchor and decide whether to keep or sell that share based on the actual fundamentals impacting the share price.
Loss Aversion
This is one that has visited us all at some stage… Basically we hate losing far more than we enjoy winning, in fact some researchers have suggested that the pain of losing stays with us twice as long as the joy from winning. Listen to Roy Keane – some of the big losses in his career still gnaw away at him, while he rarely thinks of the successes he enjoys. Doug Sanders, who lost the British Open in golf in 1970 after missing a 3ft putt on the last hole was asked about how often he thought about it. His answer was that thankfully it got easier with time – he now only thinks about it once a day.
When it comes to investing, we can cloud our decisions by the small losses we suffered. The pain of accepting a loss and moving on is too great in our minds and can stop an investor selling a stock at a loss, even though the future outlook might not be good. People can become frozen with the fear of losing.
Confirmation
The nodding donkey… We all have pre-conceived ideas about subjects, even ones where our basis of opinion is questionable. Then you receive more information that appears to “confirm” your previous hunch, and this guides a decision. The challenge with this is that you are not considering all of the available information, instead your hunch has been apparently confirmed as correct. When investing, it makes sense to consider all of the information available and put your own pre-conceived ideas aside. Something may show up in the new information that quickly demonstrates that your original hunch may have been misguided.
As we said back in October, the key to investing is often staying out of our own way, as our behaviours can really undermine our potential to achieve successful outcomes. Keeping up the saving habit, staying focused on the plan and not trying to time the market are all important to your long-term success. Being aware of your own biases is important too. Identify the ones that possibly loom larger in your own though processes and check yourself against them before you make an investment decision.