Neglected Emotional Biases Trap You

Let's think about two questions.

Firstly, do you tend to sell your winning investments and hold onto your losing ones?

This may be due to a loss aversion bias, which makes it challenging to accept losses and move on.

However, the winners you sold might continue to rise in value, and the losers you hold might keep going down, especially when their fundamentals have deteriorated.

Secondly, do you refuse to make decisions because you fear regretting them in the future, as you may have done in the past?

If so, you may have a regret aversion bias, which can lead to a conservative approach or a tendency to follow the herd.

They are emotional biases, which can lead to poor decision-making and negative outcomes but are often neglected.

By understanding these biases, we can take steps to minimize their influence and make better decisions.

Now, I will walk you through two other common emotional biases.

It is normal to develop an attachment to a product after using it for the free 30-day trial and eventually buy it.

In this scenario, the seller may be taking advantage of your endowment bias.

This bias, also known as "the ownership effect", causes people to perceive things they own or might own as more valuable.

Why did this happen?

We tend to develop a preference for things that are associated with us.

Also, this is somehow related to the loss aversion bias, which causes people to feel pain due to what they might lose.

When it comes to investing, investors might be reluctant to replace the poorly performing stocks they hold with better performing ones.

Investors who are affected by the endowment bias are likely to convert short-term trades into long-term positions and hold onto mediocre assets.

As a result, they may have an overvalued and poorly allocated portfolio that doesn't align with their risk tolerances or financial objectives.

To mitigate the impact of this bias, investors can ask themselves questions such as, "What is the opportunity cost?" and "How would I invest now if I had the same amount as my current portfolio?"

By surrounding yourself with plans, rules, and data, you can create a more rational and objective environment that helps to reduce the impact of emotional attachment.

Let's consider another question.

Are you very confident that your investments will outperform the average?

If you give a firm "yes" answer, perhaps you are affected by the overconfidence bias.

Some people tend to overestimate their abilities or performances, especially in two ways.

One way is that they overestimate their knowledge or the ability to access information.

For instance, they may be overly confident in their predictions, expecting a much smaller stock price range than what is realistic.

Or they may have certainty overconfidence to overestimate a specific event's probability.

An example is that they might be convinced that a particular stock has a 99% chance of rising.

Another way is that they have a self-attribution bias.

Whereby individuals attribute their successes to their own abilities while blaming others for their failures and repeatedly making poor choices..

Generally, investors affected by this bias tend to overestimate their judgment of the market or specific investments, disregarding negative signals or other useful information.

They underestimate risks, overestimate profits, stick to specific risky investments, lack diversification in investing, and trade too frequently.

Once you notice an overconfidence bias, you'd better do something.

Look back, find out how your past decisions were made and how they led to poor outcomes, and compare them with more rational decisions.

Also, reposition yourself to take a more objective view and listen to what others say.

Actually, not only can each emotional bias lead to loss, but the various biases can work together and end up with greater losses.

It is necessary to review and analyze your portfolio regularly and promptly adjust it based on your plans and goals.

What emotional bias might you have? Please share with us.