Behavioural Biases in Investment Decision Making

What Is Bias? 

According to Investopedia - A bias is an illogical preference or prejudice. It's a uniquely human foible, and since investors are human, they can be affected by it as well. Psychologists have identified more than a dozen kinds of biases, and any or all of them can cloud the judgment of an investor.

Some of the well documented biases that are observed in Investment Decision Making are 

Optimism or Confidence Bias -: Investors cultivate a belief that they have the ability to outperform the market based on some investing success.  Investing on objective information tends to remove this bias. 

Familiarity Bias -: This bias leads investors to choose what they are comfortable with.  This may be asset classes they are familiar with, stocks or sectors they have greater information and so on. This bias can lead to concentrated portfolios. 

Anchoring -: Investors hold on to some information that may no longer be relevant and make their decisions based on that.  New information is based as incorrect or irrelevant and ignored in decision making process. 

Loss Aversion -: The fear of losses leads to inaction.  Studies show that the pain of loss is twice as strong as pleasure that felt at a gain of a similar magnitude.  Investors prefer to do nothing despite information and analysis favouring a particular action that in the mind of the investor may lead to a loss. 

Herd Mentality -: This bias is an outcome of uncertainty and a belief that others may have better information, which leads investors to follow the investment choices that others make. 

Recency Bias -: The impact of recent events on decision making can be very strong.  This applies equally to positive and negative experiences.  Investors tend to extrapolate into the future and expect a repeat.  A bear market or a financial crisis lead people to prefer safe assets.

Choice Paralysis -: The availability of too many options can lead to a situation of not wanting to evaluate and make a decision.  Too much information also leads to a similar outcome on taking action. 

(Disclaimer : This blog is for information purposes only)