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3 Cognitive Biases Investors Need To Be Aware Of

There are several biases that can affect investors’ decisions, especially when in downturns and speculative markets — what are they?

It may sound a bit over the top, but when it comes to investment decisions, being as unemotional as possible is generally a good tactic. Too often, investors catch themselves getting caught up in the short-term narrative pushed by media outlets or the opinions of others.

These are three biases at play that all investors need to watch out for. 

1. Confirmation bias

Perhaps the one we all struggle with most in our everyday lives is confirmation bias. This is purposefully seeking out information that is favorable to your opinion or situation. For example, if you own Ford stock, you might search for “why is Ford a good investment?” to reinforce your position rather than “why isn’t Ford a good investment?” to reassess.

It goes back to my point of being unemotional when making investment decisions. The most dangerous of all some might say — is when the collective hive mind can overpower realistic thought and analysis — such can be the case with unobjective stock discussion forums. Cult stocks like Palantir and Tesla arose and succumb to this particular trait, and it causes investors to be ignorant to the greater landscape and visible risks that can be ongoing with the business. 

2. Information bias

A short-term narrative is often pushed towards us by media outlets. The access to minute-by-minute news has only heightened the likelihood of information bias as a result. In certain circumstances, irrelevant news appears in front of us aiming to induce an emotional reaction from us as readers, listeners, and viewers. But, in actuality, stories generally will garner attention for no more than a few days, weeks, or months before the market moves on to the next big thing.

What’s far more beneficial for investors is retaining the key information relevant to the businesses they are invested in, and monitoring any major impacts that may affect the long-term thesis of an investment. And not much else to be honest! Avoid being entwined with price swings if it doesn’t alter the performance of your investments, and double-check all sources you get the information from. Multiple sources with unique viewpoints are always the best way to achieve a non-partisan summary of the event at hand. 

3. Anchoring Bias

Anchoring bias may be the most pertinent of all in this list in the current circumstances. This tends to affect investors when justifying an opportunity even when circumstances have changed. For example, in 2021, the speculative boom led to reckless undeserved valuations that had years of unproven growth built into the valuations of countless companies. The ‘Buy The Dip’ mentality has entranced market participants in recent years, and in some cases, not in a good way.

Given the surge and fall of many stocks — particularly growth — investors tend to believe that all stocks will eventually retrace back towards their historic heights. For some, this will be the case, but not for all. Many of the companies that gained traction in the last number of years still have nothing to show for themselves in regard to revenue, no feasible long-term business model, no competitive advantage, and mountains of debt. Sorry to be the bearer of bad news, but some of these stocks will fail. There are no guarantees.

We all know the deal when we sign up — “past performance is not an indicator of future success.” As such, it’s our job as investors to make informed, calculated decisions that maximize the probability of a successful outcome, and hopefully, outsized returns.

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