3 Cognitive Biases You Should Learn to Recognize If You Are Entering

3 Cognitive Biases You Should Learn to Recognize If You Are Entering

Taming our monkey minds takes patience and compassion. The behavioral finance literature tells us that no matter how educated, experienced, or prudent we are, we are all subject to systematic biases that influence our decision making.

The behavioral finance literature tells us that no matter how educated, experienced, or prudent we are, we are all subject to systematic biases that influence our decision making.

The human brain is complex and mysterious. Understanding how our brains make investment decisions requires a combination of deep self-reflection and empirical observation.

Overcoming our cognitive biases is not easy and overcompensating can lead to a whole new set of biases. For example, if you consider yourself too much of a risk-taker, you might decide to consciously constrain your investment decisions, but if you constrain yourself too much, you might end up missing some lucrative opportunities.

We can improve our decision making by studying human behavior, but even then, as the subjects of our own study, we are exposed to the very vulnerabilities we are seeking to understand. This Catch-22 of behavioral analysis makes uncovering biases and finding effective remedies all the more difficult. Unfortunately, we need to accept that, as emotional beings, all of our decisions will inevitably be subject to some degree of irrational thinking. Taming our monkey minds takes patience and compassion.

However, as we enter a new phase of the Covid-19 pandemic, there are some important points to bear in mind that can help us make more calculated decisions. Here are three of the most important cognitive biases to be aware of if you plan on entering the market.

1. Loss aversion

In the current climate, where market volatility is elevated and investors are on high alert for turning points and corrections, exercising our rational decision-making faculties becomes harder. If we allow panic to set in, we risk making spur of the moment decisions that could come back to bite us hard.

In a crisis, not only is volatility high but because of the psychological forces related to loss-aversion and attention, the impact of that volatility on investors is likely to be higher still.

Exercising discipline is key, and investors would be wise to heed the advice of Vanguard’s founder Jack Bogle: don’t peek.

We need to remind ourselves that investing is for the long term, which means we should not be measuring the performance of our investments day to day, or even month to month. If you check your investments every day you will see them fall about 50 percent of the time. If you check in every year, because the market tends to rise in most years, you are far less likely to observe a loss.

investing cognitive-bias business finance psychology

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