Submitted by nsscadmin on
Our series on DIY investing concludes today with a look at cognitive biases that may be affecting your DIY investing behavior without you even knowing it. These biases not only affect how you buy and sell investments but also how long you may hold an investment.
Overconfidence effect: Overconfidence can be extremely harmful to DIY investors. It is a well-established bias that leads you to overestimate your understanding of the stock market and take greater risks. It can also lead you to ignore red flags and make poor investment choices. A stock pick that caused an investor to double their money can cause overconfidence and make them feel they can only pick winning stocks.
Herding behaviour: This is also commonly referred to as fear of missing out, or FOMO. Herding is the tendency for humans to want to follow the crowd. The fear of missing out on a big investment that everyone else seems to be going after can lead to impulsive and dangerous investment decisions.
Confirmation bias: This is a problem with social media and the web in general and has bled into investment decisions. A confirmation bias is when you have a preconceived notion about an investment and seek out information to support that belief instead of building an understanding on objective research and data.
Loss aversion: This is the tendency for you to place more importance on losses and avoiding them. This can lead you to hold onto a stock even though it continues to drop in value and all rationale tells you to sell. You continue to hold in belief that the stock will go back up to the price you bought it. It can also affect profit gains causing you to sell a stock to realize a gain despite research and analysis telling you it should be held longer for a potentially greater profit later.
Anchoring: Anchoring is when you anchor your opinion and value of an investment to one piece of information or price and ignore the company’s fundamentals. Anchoring can quickly lead to confirmation bias, having you look for additional information that aligns with your anchored belief in the stock. For example, you bought shares of a company at $100 and it reached $125 this summer. It’s now down to $50, but you’re sure it will go back up to that $125 price soon and continue to hold it.
Cognitive biases can be extremely harmful to DIY investment decisions. Review your previous DIY decisions for any of these biases and keep them in mind when making investment decisions.
After reading through our entire DIY investing series, is DIY investing the right choice for you? It’s ok if it’s not. Some people prefer to work with an adviser and have their investments managed because DIY investing does not work for them. If you do proceed with DIY investing make sure you do your research, acknowledge any potential biases you are facing and address them to ensure you continue to make informed investment decisions.