Something that may have slipped your attention may be the field of behavioural finance. Yes, there is such an area of study, and it can explain why investors may behave the way that they do, taking investment decisions as a result. A psychological bias or a behavioural bias occurs when we use mental shortcuts while making complicated decisions. The bias tends to propel our behaviour in a certain direction, and this influences what decisions we take in financial circumstances. Biases are unconscious ways of thinking and these affect our behaviour, particularly investment behaviour.
Psychological Bias in Finance and Investment
Investors’ behaviour is often studied in the markets, and this is based on how investors interpret specific information and act on it. For example, while undertaking online trading, what makes an investor make a trade, and another forgo it? These are the questions that behavioural finance askes, among other pertinent questions. While making an investment decision, your judgement can well be biassed, and this may result in you making erroneous investment decisions.
Psychological Bias in Investment
There are five common types of psychological bias, also known as cognitive bias in investment. Biases influence your relationship with handling money. However, if you are aware of these, you could possibly control them. Check out the biases and how they affect you financially:
- Bias #1: Aversion of Loss - This is a bias aimed at avoiding any losses and only making profits. For instance, studies have found that more people are sensitive to losses than they are, comparatively, to gains. While making an investment, an investor may take much too little of a risk, rather than too much or a moderate amount. Consequently, investors avoid even a small degree of risk as they feel it may result in losses, when it could prove fruitful.
- Bias #2: Mental Account - A psychological bias that refers to the way people look at money differently based on where it was created, is mental accounting. This bias makes us use money in different ways. For example, huge savings from salaries may be only thought of as useful when we’re thinking of saving it to buy a house. However, if we think of money as ‘fun money’, we may splurge it and not invest it wisely at all. This explains why ‘extra money’ may be spent without a second thought.
- Bias #3: Herd Bias - have you heard of ‘herd mentality’? The term is used frequently enough to explain why you follow in the wake of other investors, rather than think for yourself. For instance, your friends may be investing for short-term gains, and you may too, even though this is risky.
- Bias #4: Bias of Overconfidence - Investors may see an investment as better than it really is. This is true of how investors perceive themselves too. If you are an investor, you may commit this bias in investment by overestimating your knowledge or ability. Therefore, you take rash decisions, rather than informed ones.
- Bias #5: Bias of Anchoring - In the phenomenon of ‘anchoring’, you may decide your future moves based on an initial piece of information. Your judgements will be based on this. For instance, if you have bought shares at a very high value, you may hold on to them, not selling even when you can make profits. Thus, you are stuck or anchored because of the stock’s initial high price.
Move Past Your Bias
When you are an investor, you need to make conscious decisions based on knowledge and many kinds of analysis. You can do this with the MO (Motilal Oswal) Investor, by opening an account an app that gives you sound investment advice, and helps you reach your investment goals.
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