Indians still prefer cash despite rising digital payments

Confirmation bias is our inclination to seek out information that supports our previously held thoughts and opinions while ignoring information that contradicts them.

Our instincts drive us to pile on to things when things are going well and to flee when things aren’t. This is precisely the opposite of what should be done when it comes to investing. That said, humans are not rational, according to behavioural finance. Humans in economics textbooks have always been assumed to be rational, unbiased, and optimisation-seeking decision-makers.

In reality, we are driven by emotion, make irrational decisions based on incomplete knowledge, and think irrationally. Behavioral finance acknowledges this and educates us on all the common personal financial blunders we make. Let’s look at typical investing behavioural blunders so you can prevent them:

Excessive assurance

Overconfident investors frequently believe that market predictions are achievable and that they know how to accomplish them. That said, many times, overconfident investors execute more trades to match their positions with current market conditions.

The cost of these frequent trades piles up, generates taxable gains, eats into profit margins, and rarely results in further returns when an overconfident investor does not get the desired outcomes and makes even more deals, like a cat chasing its tail.

Irrational confirmation bias

As an investor, we prefer to believe that we obtain all necessary information before taking action. Confirmation bias is our inclination to seek out information that supports our previously held thoughts and opinions while ignoring information that contradicts them. We establish our opinions first, then look for evidence to back them up.

Confirmation bias can be quite costly to your investment portfolio, particularly if you are investing in high-risk assets. You must keep information channels open and look for ways to challenge your concept or view to overcome this bias. To avoid falling into the trap of confirmation bias, consider examining the proposition from several angles. Look for the advantages and disadvantages and alternate information from multiple sources to get a balanced perspective.

Worry

Worry is a natural — and widespread — human emotion. Worry elicits memories and conjures up ideas of possible future events, all of which influence an investor’s financial decisions. Anxiety about a potential investment raises the perceived risk and lowers risk tolerance. Investors should match their degree of risk tolerance with an adequate asset allocation plan to avoid this bias.

Heard mentality bias

When an investor invests, they are said to be following in the footsteps of other investors and/or the majority, rather than basing their decision on real-time, accurate financial data.

The reason investors follow the herd is because it appears to be reassuring and moves them in the same direction as the herd. This bias is also known as the ‘bandwagon effect,’ which arises when some investors follow another investor’s investment selections.

On the other hand, herding may not always keep you safe; occasionally, investors are ignorant that the herd is approaching a cliff that would result in a steep fall. You can find yourself making foolish investment choices that aren’t appropriate for your portfolio.