Is Bias Influencing Your Investment Strategy?
Without even knowing it, there are factors at play in our investment management strategies that could be putting our financial security at risk. In addition to external influences (e.g. market volatility, federal regulations, even social media) that can affect our decision-making, our own innate behavioral biases can also impact our investment decisions.
Emotional vs. Cognitive Biases
Every investor has biases – whether they are experienced or not – and some biases are stronger than others. These biases are frequently divided into two categories: emotional and cognitive.
Emotional biases are triggered by our own feelings and are often spontaneous in nature. At the time an investment decision is being made, your personal emotional state and experiences can deeply impact your choices. Specific examples of emotional bias include:
- Loss-Aversion Bias: Putting higher emphasis on avoiding losses than making gains
- Overconfidence Bias: Thinking that one’s abilities and skills are greater than they are
- Endowment Bias: When an individual places a greater value on an asset they own vs. one they do not
Cognitive biases are less emotion-driven, but rather involve making decisions based on subjective reasoning, judgment and perception – which may or may not be accurate. Specific examples of cognitive bias include:
- Conservatism Bias: Maintaining an existing view or opinion while ignoring new information
- Illusion of Control Bias: Individuals’ belief that they are in control of the results when they are not
- Framing Bias: In which a person answers a question differently based on the way it was asked (framed)
Tips for Combating Investment Bias
There are many different consequences of these biases, and oftentimes, they are so embedded in our thinking that we don’t even recognize their influence. These tips can help combat the potential negative influence of emotional and cognitive biases:
- Have a long-term strategic plan. This can help investors stick to their asset allocation knowing they are taking the appropriate level of risk into account.
- Know what you own. This will give you confidence in your investment plan and help you to avoid costly mistakes as a result of biases.
- Don’t try to time the market. Have a systematic dollar-cost averaging strategy.
- Work with a professional or get an extra set of eyes to review your investments. This can help mitigate the impact of behavioral biases.
Simply acknowledging that these biases exist in each one of us is an important first step. If you’d like to discuss potential biases in your investment strategy or would like to review your existing portfolio, please don’t hesitate to connect with a member of the MFA Wealth Management Team.
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