Whether you’re buying a new car or simply deciding what you fancy for dinner that night, as humans we all use short cuts to make choices. More often than not, it can be a positive as it means we can make decisions that work for us in a timely manner.
That said, these short cuts in our decision-making process, which are otherwise known as biases, can lead to poor decisions when it comes to investing. Worse still, you may not realise that these biases are controlling your decision-making process, which could result in you repeatedly making choices that you later regret.
So, with this in mind, read on to discover five powerful biases that you may want to avoid, and why falling foul of them could cost you dearly.
1. Loss aversion
This is one of the most powerful biases and is driven by the human desire to avoid losses. Various studies have suggested that humans feel the pain of loss more deeply than the pleasure of a gain, which is why many investors consider loss avoidance to be as important as making gains.
Loss aversion is often behind the decision to sell investments when the stock market suffers a downturn. More often than not though, doing this in a bid to avoid further losses increases the possibility of actually making one.
Just as importantly, it also deprives the investment of any potential to recover when the stock market bounces back, which historically, it’s tended to do. That said, please remember that past performance is no guarantee of future performance.
2. Confirmation bias
Confirmation bias is when a decision is made based on a preconceived idea and is one of the most common emotional biases when it comes to investing. This could result in you, for example, researching an investment when you’ve already decided whether it’s right for you or not.
This increases the chances of you making a decision that’s based on a pre-established assumption instead of factual evidence. As a result, you could go ahead with your original investment idea despite all the evidence showing that it’s not the best option.
3. Anchoring bias
This refers to an over reliance on a specific piece of information, which could result in you making a decision using data or information that was once correct but isn’t any longer.
An example of this might be you deciding to place your money into an investment because someone once told you to do so, when in fact, it’s no longer right for you. Conversely, you may fail to sell your investment when you should.
4. Endowment effect
This bias results in investors giving certain funds or shares that they own a higher value than the ones they don’t. As a result of this belief that the funds or shares are more valuable than they really are, the investor is more likely to hold on to an investment when the better strategy could be to sell it.
If you fall foul of the endowment effect, you may hold on to a fund or shares instead of letting go of them, only to see them plummet in value later on.
5. Bandwagon effect
This is a particularly dangerous bias during a stock market downturn. In a nutshell, its where individual investors make a decision that’s based on a commonly held belief.
As we have already seen, loss aversion can drive many investors to sell up when the markets become volatile. If you see other investors selling, you could fall foul of the bandwagon effect and decide that this is the best policy and do the same, when in fact, it might not be.
Please remember that if you’re considering selling your investments during a downturn, you should always take extreme care and speak to a financial adviser before going ahead.
A financial adviser can help you to avoid these damaging biases
Working with a financial adviser could be an extremely shrewd strategy, as they can provide an independent opinion about the actions you’re considering. This means they’ll confirm whether it’s the best option available to you, and help highlight any risks that you need to consider.
They’ll also provide alternative actions that you may want to consider, which could help you to sidestep a costly mistake. Furthermore, it might expose your money to greater growth potential.
The latter is backed up by research carried out by the International Longevity Centre UK, which makes for interesting reading. It found that people who worked with a financial adviser were on average £40,000 better off than those who don’t.
If you would like to discuss your investments, or wider wealth, we’d be happy to help. Please call us on 01527 577775 or speak to one of our advisers.
We’re here to help
While we hope this blog is useful, it’s not intended to be advice. If you are feeling anxious about the volatile stock market, speaking to a financial adviser could help. They can explain what’s happening with the markets using clear and easy to understand language, which could help put your mind at rest.
Additionally, they could also help you to understand what your options might be, and which could be best for you. If you have investments and would like to discuss the potential impact of the Liberation Day tariffs on your portfolio, and the actions you may need to consider, please contact us on 0333 010 0008. We would be happy to arrange no obligation meeting with one of our advisers.
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Monday 14 April 2025