The human brain is powerful. It’s put us right at the top of the food chain, despite humans being smaller than elephants, slower than lions, and weaker than bears.

How is this possible? One reason is our ability to effectively process information. Part of that involves using mental shortcuts – called heuristics – to quickly make decisions and judgements in the face of overwhelming amounts of information.

When choosing where to eat, we’ll lean on a friend’s recommendation or a 5-star Google review, rather than assessing all available options.

While shopping for groceries, we’ll stick with brands we know instead of comparing all products on the shelf.

We rely on a doctor’s authority when making medical decisions, gravitate towards people who display similar traits to ourselves, and can quickly judge a person based on the first few minutes of meeting them.

These mental shortcuts are helpful. We can operate effectively without being paralysed by choice. But they can also lead to biased or irrational decisions. And we’re often unaware of the biases that plague our rational thoughts.

You Are Your Worst Enemy When It Comes To Investing

Investing today is more challenging than ever. With endless data, news, and opinions, it’s easy to feel lost and make mistakes. Cognitive biases play a big role in this confusion.

Working with trusted professionals is important, but it’s not enough. To improve your investment decisions, you must understand cognitive biases and learn how to manage them effectively. Here are ten common cognitive biases that can impact your investing.

1. Confirmation Bias

What It Is: The tendency to seek out information that confirms our beliefs.

Why It’s Harmful: It leads to ignoring information that contradicts our views, resulting in poor investment choices.

How to Overcome It: Actively look for information that challenges your views. Consider opposing perspectives and diversify your sources.

2. Anchoring Bias

What It Is: Relying too heavily on the first piece of information encountered.

Why It’s Harmful: Decisions get based on arbitrary anchors like initial stock prices, rather than thorough analysis.

How to Overcome It: Focus on the intrinsic value of the investment. Conduct independent research and use multiple data points.

3. Overconfidence Bias

What It Is: Overestimating our knowledge and abilities.

Why It’s Harmful: Leads to excessive risk-taking and underestimating potential downsides.

How to Overcome It: Regularly review your investment decisions. Seek feedback and set strict risk management rules.

4. Herd Mentality

What It Is: Following the actions of a larger group, ignoring our own analysis.

Why It’s Harmful: Causes buying high and selling low as investors chase trends.

How to Overcome It: Develop a clear investment strategy based on your research and goals. Stick to your plan, even when it goes against the crowd.

5. Loss Aversion

What It Is: Preferring to avoid losses over acquiring gains.

Why It’s Harmful: Holding onto losing investments too long or avoiding necessary risks.

How to Overcome It: Set predefined criteria for selling investments. Focus on long-term performance rather than short-term losses.

6. Recency Bias

What It Is: Giving undue weight to recent events over historical data.

Why It’s Harmful: Making decisions based on short-term trends rather than long-term fundamentals.

How to Overcome It: Avoid impulsive decisions based on recent news. Don’t make big decisions without first sleeping on them, or conducting sufficient due diligence.

7. Familiarity Bias

What It Is: Favouring familiar investments, even if they aren’t the best choices.

Why It’s Harmful: Leads to a lack of diversification and increased risk.

How to Overcome It: Diversify your portfolio. Research unfamiliar investments to make informed decisions.

8. Availability Heuristic

What It Is: Basing decisions on readily available information.

Why It’s Harmful: Overestimating the likelihood of recent or highly publicised events.

How to Overcome It: Ensure decisions are based on comprehensive research and data. Take the time to gather and analyse all relevant information.

9. Endowment Effect

What It Is: Overvaluing assets simply because we own them.

Why It’s Harmful: Holding onto underperforming investments due to emotional attachment.

How to Overcome It: Review your portfolio objectively. Be willing to sell underperforming assets and reinvest in better opportunities.

10. Sunk Cost Fallacy

What It Is: Continuing to invest in a losing proposition because of past investments.

Why It’s Harmful: Throwing good money after bad, leading to further losses.

How to Overcome It: Focus on the future potential of an investment. Make decisions based on current and future benefits, not past costs.

The Bottom Line

Cognitive biases can cloud our judgement and lead to poor investment decisions. By recognising and overcoming these biases, you can make more rational and informed choices. This is difficult in practice because we’re often unaware of the biases that cloud our judgement. That’s why it pays to work with a trusted, competent adviser whose interests are aligned with yours.