Financial Services

6 cognitive biases that can derail your portfolio

1. Overconfidence. Clients affected by this bias often overestimate the confidence level and the accuracy of their own judgment as greater than the objective accuracy of those judgments. In other words, the subjective estimation of our own accuracy and reliability is greater than it objectively is.

This bias can result in an investor who has an unrealistically positive view of performance and results. To overcome relying on our own confidence, rather than data, it is important that we ask ourselves if our judgment is based upon our own level of knowledge or if we have applied due diligence in research and fact gathering.

2. Familiarity. We often make assumptions during the decision-making process based upon patterns and outcomes we’ve previously observed. For example, when we select funds to invest in, we often select those that are the most familiar or ones we recognize. This bias can result in an investor that is immobilized, despite the possible benefits that can come from diversification. To put this bias to rest, we must understand our need to seek out patterns where there are none and commit to remaining open minded about things we may not have heard of before.

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3. Information overload. When we are under stress or are being hit by too much information, we naturally adopt coping mechanisms. One of these mechanisms is to oversimplify the problem. The problem with this tactic is that, the less knowledge and understanding we have about our investments, the less we cope.

This bias can result in an investor who is readily paralyzed at the prospect of too many choices. To control our innate desire to oversimplify issues, we must tap into our patience and affirm to ourselves that we are not simply taking the easy way out rather than doing the work necessary to reap the benefits.

4. Anchoring. Once an option presents itself, we sometimes anchor ourselves to this original piece of information, failing to sufficiently adjust our mindset or consider the realm of other possibilities. This means we selectively filter out information, preferring to focus on data that support our views. This bias can result in an investor who may only look at options which support their original view, rather than seek out information that informs other views.


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