Could the way your brain works be impacting on your investment decisions?
Hamish Douglass, Chairman, CIO and Lead Portfolio Manager at Magellan Financial Group, believes so. There are certain cognitive biases, he says, that can lead us to make investment mistakes and poor decisions.
“Cognitive biases are ‘hard wired’ and we are all liable to take shortcuts, oversimplify complex decisions and be overconfident in our decision-making process”, he says. By understanding and overcoming these biases, we can make better decisions, lower risks, and improve on our returns. These biases include:
- Confirmation bias
Confirmation bias is the tendency to look for or interpret information in a way that is consistent with our existing beliefs. Douglass believes that this is a major cause of investment mistakes: the more data we get that appears to confirm what we already believe, the more over-confident we are likely to become and the more likely it is that mistakes will be made.
Instead, he says, we should be challenging our beliefs more regularly, and spend more time seeking out information that may go against what we assume to be true.
- Information bias
Also known as measurement bias or observation bias, information bias is a result of the huge amount of information that investors are bombarded with every day. It involves using information that is actually irrelevant to assess our investment decisions.
With so much information out there, it is vital that we use the right information when deciding what to do next. Using the wrong information could lead investors to sell great investments during a temporary share price blip, for example – or to buy investments that are hyped up and whose prices have recently risen, but which aren’t likely to be strong performers in the future.
- Bandwagon effect (group think)
An important trait for any good investor is the ability to think independently. However, it is very easy to be swayed by the bandwagon effect, or group think: the fact that many other people are behaving in a certain way or believing a certain thing.
While this mentality can sometimes yield good results, it is not always the case. By undertaking your own analysis and having conviction in your findings, you may outperform others even though you are doing something completely different.
Read the full list of 10 key cognitive biases that Douglass has identified, here.
“Stable Rise Limited is not authorised or registered by the Financial Conduct Authority. The marketing materials are not intended to provide financial advice nor promote any individual financial products.”