Behavioural finance: 6 ways bias affects your financial decisions

January 6, 2023

How much does bias affect your financial decisions?

You may try to make decisions based on facts but it can be much easier than you think to be influenced by emotions or bias. When bias occurs it can lead to ‘irrational’ decisions. This bias can impact your ability to achieve your financial goals.

1. You hold on to certain information

When you make financial decisions, there may be a lot of information to process. So, you may focus on one piece of data. We call this ‘anchoring bias’ because your view is 'anchored' to the information. For example, when you think about how valuable an investment is, you may 'anchor' your view to a previous share price. Even if further data means this is no longer accurate, you'll disregard it. Because you view the investment as being more valuable than it is, you might hold on to it for longer than you should. Being blinded by a specific piece of information could mean you’re not looking at the full picture when you make financial decisions.

2. You’re too cautious

Often, when you think about making investment mistakes, taking too much risk comes to mind. Yet, being too cautious when making financial decisions could be just as damaging. Psychology theory suggests that you feel the pain of losses more than the joy of gains. So, it’s natural that you’d want to avoid a loss. That could mean you choose to take too little investment risk or not invest at all due to fear of potential losses. Yet, being too cautious could erode value and affect your plans. It could mean you miss out on opportunities to grow your wealth even if they’re suitable for your risk profile and goals.

3. You’re overconfident

In contrast to being too cautious, overconfidence can be damaging too. It can mean you don’t manage risk properly and could lead to reckless financial decisions. Overconfidence can mean you overestimate your abilities. Despite markets being unpredictable, some people believe they can time the market to maximise returns. This is something we often see in investing. Overconfident investors will often claim 'wins' to their skill and knowledge but blame their 'loses' on things out of their control. This mindset can lead to investors taking on even more risk that may not be right for them and a short-term outlook.

4. You follow the crowd

There’s something comforting about doing something that everyone else is. It can make you feel like you’ve made the ‘right’ choice because everyone can’t be wrong, can they? Herd mentality is another bias that can often be seen in investing. If all your colleagues are talking about an opportunity they believe will deliver returns, you can feel left out if you’re not part of it. You don’t have to know the people to be affected by herd mentality, reading the news or financial commentary can also encourage you to follow the crowd. It’s a bias that can mean you make decisions that aren’t right for you.

5. You seek information that supports your views

It’s normal to seek out people that have like-minded views. It’s a bias that can affect how you seek and process information too. Known as 'confirmation bias', some people will place a greater emphasis on information that reaffirms what they already believe. For example, let's look at the ESG investment market. If someone lacks confidence in this market, they will focus more on the negative market reviews and disregard the positive. This can mean you discard valuable details without giving them the attention they deserve.

6. You give all information the same level of importance

How you process information can lead to bias. In the case of information bias, you give all information the same level of importance even though they could come from very different sources. When you’re bombarded with information, it can be challenging to decide what to focus on. Yet, understanding that not all information is equally useful is important.

Knowing which information to discard and which to use to guide your decisions is difficult. Improving this process could help you make choices that are better for you.

Recognising bias can help you overcome it to make better financial decisions

Realising that bias could affect your financial decisions can mean you’re in a position to spot the signs and start to make better choices. If you have any questions about your financial plan or would like our support when making decisions, please contact us.

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.

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