When it comes to making financial decisions, emotions and psychological biases often play a larger role than we realize. Even experienced investors can fall victim to these tendencies, sometimes steering away from sound financial decisions.
Behavioral finance explores how these biases can impact investment choices, but by understanding them, investors can become more aware of their tendencies and take steps to make better-informed decisions and avoid costly mistakes.
Common Behavioral Biases in Investing
Here are a few important ones to watch for:
Recency Bias
Recency bias occurs when investors give too much weight to recent events while ignoring longer term trends. For example, if the stock market has recently been performing well, an investor may feel overly confident that this upward momentum will continue, leading them to increase risk without fully considering potential downturns. Conversely, during a market slide, recency bias may cause investors to panic and sell off investments prematurely, fearing further losses. In both cases, impulsive decisions driven by recent events can hinder long-term success.
Overconfidence Bias
Overconfidence bias is another frequent pitfall of many investors. When affected by this bias, an investor may believe they have superior skills or insights, leading them to take on excessive risks or trade more frequently than necessary. While confidence is valuable, overestimating one’s abilities can result in costly mistakes. Studies have shown that even experienced investors can fall victim to this bias, often assuming they can outperform the market when statistics suggest otherwise.
Loss Aversion
Loss aversion is the tendency to feel the pain of losses more intensely than the pleasure of gains. This emotional response often causes investors to hold onto losing investments longer than they should, in the hope that they will recover. As a result, investors may end up clinging to poor-performing assets, missing out on better opportunities elsewhere.
Anchoring
Another bias to watch out for is anchoring. This happens when investors get stuck on certain information, like the price they originally paid for an investment. Because of this, they might ignore changes in the market, which can lead to missed opportunities or poor decisions. It’s easy to hold on too tightly to an investment just because of what it was once worth, even if it's now heading in the wrong direction.
Confirmation Bias
Confirmation bias occurs when investors actively seek information that supports their existing beliefs while ignoring evidence that challenges them. This tendency can lead to overconfidence in certain investment choices or reluctance to adapt to changing market conditions. For example, an investor convinced that a particular stock is poised for growth may focus only on positive news about that company, while overlooking signs of potential trouble.
Herd Mentality
Herd mentality occurs when investors follow the crowd rather than making independent decisions based on solid research. This behavior is common during market booms and busts, where investors rush to buy when prices are rising or sell when panic sets in. While it’s natural to feel influenced by others, blindly following the crowd can result in buying high and selling low—a dangerous combination.
Conclusion
Understanding these common behavioral pitfalls can empower investors to make more rational decisions and improve their financial outcomes. By recognizing when emotions are influencing financial choices, individuals can take proactive steps to develop better habits. Staying disciplined, seeking diverse perspectives and focusing on broader trends can go a long way in helping you make smarter financial decisions. Embracing patience, curiosity and a well-structured plan can turn awareness of these biases into a meaningful advantage—keeping you on track toward lasting financial success.
With a solid financial roadmap in place, you can have peace of mind that you’re on the right path. The Busey Wealth Management team can help you create a plan with your unique goals in mind. Learn more at busey.com/wealth-management.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.