5 Bias hotspots to consider

We have been doing some work recently with large finance and investment firms on decision making and the risk of bias in investment decisions. This got us thinking about our own individual investment decisions where the safety net of poor decision making is not as strong as a large investment firm.

So as an individual investor, what are 5 of the most common biases that may be steering you without you even realising it?

Confirmation bias

Confirmation bias is the tendency for us to only look for, and more importantly, only accept information that confirms what we already believe to be true. Likewise, we also tend to ignore, avoid, and reject information that disconfirms or challenges our knowledge or beliefs, but not by choice. Rather, this bias is more subtle and can affect which information gets our attention and sticks in memory helping you to be more easily persuaded by a favourite analyst or commentator because it fits with what you were already thinking not because of the quality or value of the information. This is one of the main risks of confirmation bias.

Disposition effect

We have a general disposition to sell winners too early and hold on to losing positions too long (Shefrin & Statman,1985) reflecting very basic psychological processes of the desire to realise success and avoid regret. This bias can shape thinking at both ends of the market (e.g., an investment you made “cannot go any lower” or “better to realise profits than risk the fall after a peak”. This affects both large and small investors and this can also mix with a temporal effect when you might sell in a period when others are selling because it’s the end of the tax year. Or as one investor told us that their strategy is to always ‘sell in May and stay away.’

Availability bias

We’re surrounded by data, information and AI tools, yet we tend not to look too or far wide – sometimes even at all –for information to guide our investment decisions. Availability bias describes our tendency to focus and over-rely on information that is easiest to access or recall, either from our own memories or the external environment. You’re especially vulnerable to availability bias when that one story from your own experience, or a trusted friend contrast the harder to find and typically more complicated data that you know you should be looking at.

Anchoring

You’ve opened the menu and in a bolded box in front of you is what you think must be the world’s most expensive steak, £600 plus. Now you know that you would never pay that amount for a meal, ever, but what that has done is anchor your decision making around £600. Before you know it, the £100 hamburger looks like great value. When we are over-reliant on the first piece of information that you see or hear, this is the anchoring effect in action.

Over-confidence

Prior to Christmas some of the Cognicity team went ice skating for the first time. At the start we hung on tightly, really tightly, to the hand rail and we wouldn’t let go for fear of falling over. After a few minutes (well, quite a few minutes) our confidence was increasing and we were now ready to skate off on our own. No sooner had we decided we were ready, we were then laying on the ice and being asked if we were ok. Put simply, early successes led us to become too confident. The same can apply to our investment decision making when we overestimate our capacity (or an investor’s capacity) to forecast market trading events and has been found to be linked to excessive and frequent trading with all the associated costs. And, as with our little like our ice-skating experience, over-confidence following a positive performance left us with bruises. In markets, these bruises from overconfidence will show up in your portfolio.

About us:

If this article has raised some uncomfortable questions about your own decisions, that’s a good sign. We work with teams and individuals to spot these biases and help you design practical guardrails and mitigating actions.

If you would like to learn more, we’d love to talk. Just drop us an email at: info@cognicity.com

Please note, this article does not constitute any individual or formal investment advice.