Mind Over Money: Demystifying The Investing Biases
Introduction
Humans are unique because we don't just think—we feel. Our emotions influence everything, from the choices we make in life to the money moves we make in the market. Fear, greed, overconfidence, or even the fear of missing out (FOMO) can push investors toward decisions that may not always be rational. These emotional triggers lead to psychological biases in financial investment behaviour, shaping not only our financial mindset but also our investing habits.
But here’s the good news: by recognizing these biases, you can make smarter, more objective investment decisions. This blog dives into the most common investing biases, how they affect your wealth-building journey, and, most importantly, how to overcome them to become a more rational and successful investor.
Psychological Biases In Investing
The preconceived notions or errors that influence financial decisions are known as psychological biases in investing. It eventually affects investor behaviour in the financial markets. Some of the key psychological biases in financial investment behaviour are as follows:
Emotional Investing Biases | Cognitive Biases |
Fear and Greed | Confirmation Bias |
Herd Mentality | Anchoring Bias |
Loss Aversion | Availability Bias |
Overconfidence Bias | Recency Bias |
These investing biases are discussed with examples in the blog, later.
More than a one-time decision, investment is a process or journey. It requires significant attention and care. Therefore, understanding markets, their forces, and investment behaviour becomes crucial. Moreover, understanding psychological biases in financial investment behaviour and their effect is a part of this journey.
How Do Emotions And Biases Drive Financial Decisions?
The key forces driving financial markets are supply and demand. These are associated with the actions of investors and their perceptions of the market. Investors also face certain biases or preconceived notions that affect their financial decisions, sometimes knowingly or unknowingly.
1. Emotional Investing Biases:
Other than knowing any specific information, these biases arise from the feelings and emotions of the investors. Feelings like fear, greed, specific anger, confusion, temporary indecisiveness, and more.
A. Fear and Greed
When investors fear the falling market, they start selling their investments to avoid losses without knowing the actual reason for the fall. Exactly opposite to this, when investors observe a soaring market, they seek more highs out of greed rather than finding suitable price points.
For example, in the case of economic bubbles, investors fall prey to their greed and eventually incur heavy losses when the bubble bursts. During the dot-com bubble, US stocks plunged nearly 49%1.
B. Herd Mentality
It is one of the most common investing biases. Here, the investors blindly follow the trend and make buy/sell decisions without proper analysis.
This was evident around the General Elections 2024. Due to the heavy trend towards Public Sector Unit stocks, both Nifty 50 and Sensex rose before the elections. When the results slightly varied from expectations, investors started selling PSU stocks. Due to this, these indices were almost down by 3%2.
C. Loss Aversion
In this, investors fear losses so much that they ignore the possibility of gain. This can usually happen due to a set notion in their minds or a similar experience.
Suppose equity markets are crashing, and an investor is expected to incur more than a 15% loss. To avoid this loss, they can invest in the debt market and earn potential returns. However, due to loss aversion bias, they avoid making this shift and keep incurring losses.
D. Overconfidence Bias
When an investor is extra confident about their skills or experience to earn a heavy return above their risk appetite, the potential risks may get blurred.
For example, it is mostly evident in derivatives trading. 93% of individual traders (investing more than INR 1 crore) have incurred losses of INR 2 lakhs per trader from FY 2022 to FY 20243.
2. Cognitive Biases:
These are types of investing biases that are usually related to information, perceptions and haste in investment decisions. There are different types of cognitive biases in investing, such as:
A. Confirmation Bias
It is the pattern or tendency of an individual to search for information that confirms an existing belief of an individual.
For example, suppose an investor buys a stock during an uptrend, but the stock starts to decline. Despite a fundamental weakness, the investor will confirm their belief even with the smallest of positive news.
B. Anchoring Bias
It is the tendency of an investor to over-rely on first-piece information. This leads to investors missing market opportunities.
For example, investors may stick to a support price they once discovered in the stock chart. Owing to the same they may ignore the potential weakness and hope for stock to return to that level.
C. Availability Bias
In this, an investor easily relies on the information that is easily available to them. However, it can become a hasty decision and adversely affect their portfolio.
For example, sometimes, investors may start selling their long-term bonds after the announcement of a repo rate hike. However, if that action is reversed in the near future, they may miss the market returns. Therefore, understanding the overall macroeconomic conditions becomes crucial.
D. Recency Bias
It is a behavioural hurdle that causes investors to rely on the recent information without understanding the historical trend.
It is evident in the technical analysis. If an analyst relies on a recent technical chart pattern without referring to historical price movement, the trade may fail due to a lack of sufficient information.
Identify Your Investment Personality
Based on the patterns of personal investment, analysis, risk perception, and more, an investor develops a specific personality. Usually, this investor personality type indicates their probable actions in the market and psychological biases. Experts from the field of behavioural finance suggest some personalities as follows:
Sr. No. | Personality Type | Description | Some biases that may be faced by the personalities |
1. | Planner | These types of investors prioritise financial security. They avoid highly volatile or risky investments and prefer bonds over Securitised Debt Instruments. | Loss aversion |
2. | Enthusiast | These are investors with a high-risk appetite. They are open to facing market fluctuations, options and emerging markets. | Fear and greed |
3. | Equilibrist | These are investors with a balanced approach. They have a diversified mix of conservative and aggressive investment strategies. | Confirmation |
4. | Strategist | They invest with minimal effort and their portfolios may be similar to a passive investment. Usually, assets like index funds and Exchange-Traded Funds are their preferred options. | Loss aversion |
5. | The Finance Geek | A key trait of these types of investors is reflected in their market expertise. They complete thorough analysis before investing and make strategic decisions. | Overconfidence |
Using Self-Awareness To Build Wealth
Overcoming the biases can be a tough task. However, realising them, identifying how it works and managing them can help investors build their wealth corpus.
1. Align Personality with Investment Strategy.
Investors should determine the core objectives of their personal finance and investing journey. It will help them decide the most suitable strategy for their portfolio or wealth-building journey. The suitability of strategies and their execution may differ for every investor. Therefore, rather than blindly following the one with the most returns, an investor can get inspired and use it based on personal investment.
2. Matching Risk Appetite.
Defining the risk profile by introspection is highly crucial. It will also help identify the type of investing biases hindering the journey. Investors can select assets, strategies, time and more based on risk perception.
3. Overcoming Bias and Opting for Rational Investing,
Psychological factors like biases are less talked about. However, they play a significant role in the investment journey. Investors need to observe their patterns and tendencies to identify the biases and avoid them. Moreover, rather than using fear and greed in investing, one can opt for rational decisions backed by a solid sense. The sense may differ for every investor.
Conclusion
Personal finance and investing are evolving to be one of the most crucial decisions. The psychological biases in financial investment behaviour also play a significant role in deciding the trajectory of an investing journey. Understanding different types of investing biases can help investors determine their personality. Eventually, one can avoid the biases and select the most suitable strategies.
Are you willing to explore a basket of unique investments to match your investor personality? Log in to Grip Invest today!
Frequently Asked Questions On Investment Psychology
1. How can I determine my investment personality types?
Investors can check their comfortable investment assets, risk profile, market knowledge and psychological biases. It will help determine the investment personality. Moreover, one can decide the most suitable investment strategy based on their investment personality.
2. What is the personality of an investment banker?
The individual or financial expert helping entities in investment, fund procurement, mergers and acquisitions, and more are known as investment bankers. These are accumulators or contrarians who have sufficient market knowledge and work toward building their wealth with medium to high-risk tolerance.
3. Can emotions like fear and greed be managed while investing?
Yes, using suitable strategies and understanding the market forces in action can help manage fear and greed in investing. Moreover, one can also consult their financial advisors for better guidance.
References
1. Economic Times, accessed from: https://economictimes.indiatimes.com/markets/bonds/long-bonds-historic-46-meltdown-rivals-burst-of-dot-com-bubble/articleshow/104200896.cms?from=mdr
2. Livemint, accessed from: https://www.livemint.com/market/stock-market-news/general-elections-2024-results-psu-stocks-tumble-as-early-trends-show-mixed-results-bse-psu-down-8-11717474710525.html
3. Securities and Exchange Board Of India, accessed from: https://www.sebi.gov.in/media-and-notifications/press-releases/sep-2024/updated-sebi-study-reveals-93-of-individual-traders-incurred-losses-in-equity-fando-between-fy22-and-fy24-aggregate-losses-exceed-1-8-lakh-crores-over-three-years_86906.html
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