What are behavioural biases?
Behavioural biases are irrational beliefs or behaviours that can unconsciously influence our decision making process. It is where we take action based on emotions, rather than on facts and logic.
A recent example is when governments around the world announced a lockdown almost simultaneously in March 2020 as a result of the Covid pandemic. Many people rushed to stock up on household needs and groceries. You hear of toilet papers and bread, among others, being wiped out and stored. This knee jerk reaction reflects a common behavioural bias – the herd mentality.
This behaviour is also very apparent in investments. Whenever there is a dip in the stock markets, behavioural biases will surface … and it can be very detrimental to our investments.
Let’s have a look at these 5 behaviour and see if we can identify with them.
Anchoring is where we have the tendency to be over-reliant on the first piece of information we hear. Eg., if you bought Fund A based on it giving a 10% returns last year, you may use it as a reference point when anticipating its future performance.
While we all know that past performance does not guarantee future performance, we still will use that first encounter with the fund as a benchmark and expect the same to repeat. It is always a good idea to conduct sufficient research to understand the funds, markets volatility as well as our own risk profiles and investment duration to overcome this bias.
To overcome behavioural biases, you must adopt a disciplined approach in order to succeed in your investments
2. Confirmation bias
This is the tendency to favour information that is consistent with our beliefs or our views on a subject matter. Eg, Mr. Wong once invested in the stock market and subsequently lost money. Mr Wong now believes that the stock markets (and hence all equity markets) are a dangerous place to be. Mr Wong no longer invests in any equities. When the market corrected past 3 weeks in China, Mr Wong proclaims loudly to his family that he is right all along to avoid the stock market.
This bias is dangerous because it prevents us from making money. To overcome this bias, we should be more objective when researching on investments and take every investment outcome as a lesson to be better the next time round. Many people make the mistake on relying on their past mistakes, without realising that that itself is a fresh mistake.
We do not see things as they are, we see things as we are
3. Herd mentality
To me, this is a very costly bias to possess in the investment world. This bias is the tendency of people to follow the actions of the majority, regardless of whether the actions are rational or not. This bias is very driven by the FEAR OF LOSS emotion.
A recent case in point is during the panic sell of the Covid pandemic in 2020. When the countries shut their their borders one by one, the markets reacted by a heavy selldown on equities. You will see people dumping their stocks in panic and they tell their relatives, friends, neighbours and the uncle all the way across the globe to also dump their stocks, in fear of the markets melting. And so, many did.
To overcome this bias, always have a long term investment objectives and understand that blips and bumps will always be part of your investment journey. Always look at facts and avoid listening to the advice of your relatives, friends, uncles from across the globe who are not specialist in this field.
4. Loss aversion
This follows the herd mentality where there is a tendency for people to avoid losses, even if it is paper loss. We all take the pain of a RM100 loss more than twice the happiness of gaining RM100 in our investments.
As in the case of the herd mentality, when we see our portfolio losing 20% when the market corrects, we quickly switch or sell our investments rather than to focus on our investment goals and focus on the long term market potential.
To overcome this bias, shift the focus from the immediate paper loss to the opportunities that the markets present and invest according to our risk appetite and investment objectives.
5. Overconfidence bias
How many of us have conversations with a friend who is extremely confident that his recent stock purchase is the best price, best company, best potential, best returns and therefore, has invested everything he owns in it. This is the over confident bias and this is where people believe so strongly in their decision that they are blinded to the potential risks in their actions.
As in all things, investments are not cast in stone. Everything and anything can change and can potentially go the opposite direction to what we initially anticipate. Always be open to diverse readings and be open to other potentials in the market, and to also be open to the fact that we can, sometimes, be wrong. .
Always be aware of the biases that we can face especially when dealing with money and investments. Have a set investment objective, investment horizon and adopt a flexibility of change in strategies.
Always hold a diversified portfolio and continuously rebalance when investment conditions change. Volatile markets present us with investment opportunities and we should never act irrationally when facing the uncertainties.
Remember, when the markets fall hard, the bounces back harder.