Human psychology evolved for survival, not investment success. Understanding the cognitive biases that affect financial decisions is the first step toward making more rational choices with your money.
Loss Aversion
Research shows we feel losses roughly twice as intensely as equivalent gains. This asymmetry can lead to holding losing investments too long (hoping to break even) and selling winners too quickly (locking in gains).
Confirmation Bias
We naturally seek information that confirms our existing beliefs and dismiss contradictory evidence. In investing, this can mean ignoring warning signs about investments we already own or opportunities we've dismissed.
Recency Bias
Recent events disproportionately influence our expectations. After a market rally, we expect continued gains; after a decline, we fear further losses. Long-term historical perspective helps counteract this tendency.
Overconfidence
Most investors believe they're above average, which is statistically impossible. Overconfidence leads to excessive trading, inadequate diversification, and underestimation of risks—all costly behaviors.
Strategies for Better Decisions
Awareness is the first defense. Written investment policies, automatic rebalancing, and deliberately seeking contrary viewpoints can help counteract these deeply ingrained tendencies.
Key Takeaway
Understanding behavioral biases won't eliminate them, but it can help you create systems and habits that minimize their impact on your investment decisions.