Understanding Behavioral Bias

Understanding Behavioral Bias
Learning how emotions affect decisions can make you a better investor

Are you a better-than-average driver? Chances are, you answered yes. That’s because nearly three-quarters of people think they are better-than-average drivers.1 Besides being
mathematically impossible, this statistic is an example of overconfidence—and is just one illustration of how certain biases can influence our thought patterns.

These behavioral biases sometimes help us make smart decisions. But they also can cloud our judgment and lead us to make irrational decisions. That’s especially true when it comes to
investing. At a time when markets are down and it’s impossible to predict what tomorrow will look like, our perceptual distortions can make a difficult situation worse.

The good news is recent evidence suggests that we can learn to overcome these biases and improve our decision-making. But first we have to understand how they work. Here’s a look at
three of the most common behavioral biases that can impair our investment decisions.

Anchoring

You’ve fallen victim to anchoring when your emotional attachment to the past value of an investment keeps you from recognizing its present value. For example, let’s say you own stock
that was recently selling for $100 per share but has since dropped to $60. But you may be anchored to that $100 figure, convinced that’s the right value for that stock. As a result, you may
hold onto your stock convinced it will soon rebound. However, there’s no guarantee that it will.

When assessing your investments, ask yourself whether your evaluations are based on the current reality of the assets or your past feelings about them. Weigh the merits of keeping an investment
based on current information and whether it’s still a good fit for your financial plan.

Recency bias

1 AAA, “More Americans willing to ride in self-driving cars,” 2018.

Recency bias can lead to putting too much emphasis on the latest information—and often ignoring other important data. For example, say stocks begin to climb and that uptick inspires a
surge in buying. As more investors pile on, prices climb even higher, surpassing historically expensive levels. Yet investors may ignore this red flag, assuming recent trends outweigh longterm data. However, bubbles like these can pop and falling prices can potentially leave investors with heavy losses.

You can avoid recency bias by taking a long-term approach to investing. Strategies such as dollar-cost averaging, when you make a series of regular investments regardless of the market’s
ups and downs, can help erase the temptation to chase returns or panic when prices fall.

Overconfidence

Confidence is useful and, in many cases, necessary. Investing a chunk of your income in the stock market takes confidence. And it’s confidence that allows you to keep risks in perspective
and sit tight in a turbulent market rather than rushing to sell your assets and locking in losses.

But overconfidence can be dangerous. It can lead you to believe that you know better than experts, that you can predict market movements successfully (spoiler: you can’t), or that you can
spot investment opportunities others have missed. Worst of all, it can lead to emotional decisions in response to market moves, such as buying when prices are high and selling when prices are
low.

Combat a tendency toward overconfidence by basing investment decisions not on emotion, but on careful research. Once you’ve made a decision, stick with it and avoid the temptation to try to outsmart the market by jumping in and out of investments.

Recognizing how behavioral biases influence investing can help you keep them in check. As a result, you’ll be more likely to make investment decisions that align with your long-term financial plan—and to avoid the irrational decisions that may knock you off track from that plan.

Any opinions are those of Golden Road Advisors of Raymond James and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Dollar- cost averaging cannot guarantee a profit or protect against a loss, and you should consider your financial ability to continue purchases through periods of low price levels

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