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What are our emotional biases and how do they impact our investing?

Firstly, really look at the cartoon above.  While it is funny, it is also quite true and illustrates how emotions can get in the way of investing.  This cartoon can illustrate a number of biases - recency bias, fear of missing out, anchoring effect.

In the last article we looked at the five main behavioural finance biases - Confirmation bias, Recency bias, Gamblers fallacy, Anchoring effect and the Herding effect.

This final article in the series looks at five main emotional biases - which again are usually acting subconsciously.

1. Overconfidence. It is quite common to have an over inflated view of our capabilities, which leads us to not want to admit that we got it wrong.  Sometimes, we have to just cut our losses.

2. Loss aversion. Referencing the cartoon above, fear and greed complicate successful investing. The short term fear of loss will often outweigh the benefit of long term gain. It has been calculated that investors can weigh relative losses twice as heavily as the gains.

3. Self-attribution. It is easy to attribute your successes to your own abilities only, rather than to an element of luck or the abilities of others.  This perception of 'always getting it right' can lead to over-confidence.

4. Fear of missing out or FOMO.  The influx of new investors to platforms like Sharesies and Hatch (which isn't a bad thing, it is a good way to learn if you are using a small amount of money), the recent surges in property prices, and the rise and rise (followed by the fall and fall) of crypto-currencies are all good indicators of how FOMO works. This is based on the regret of hearing about tother peoples success stories and not getting 'in on it', which outweighs all other considerations.

5. Endowment. We attribute greater value to things we already own and invest more into it without considering other opportunities that may do just as well and crated diversification. This can cause too much exposure to too few assets, although it can feel good to validate your previous decisions.

Our goal is to help our clients to be self aware and diversify and keep a steady head when things are over or under exuberant.



 

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