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What Are Cognitive Biases in Investment? Here Are 10 Common Ones

Oct 11, 2019 | 5 months ago | Read Time: 4 minutes | By iKnowledge Team

Cognitive biases are errors in cognitive processes like identifying, recalling, analyzing, or reasoning. These errors of judgement primarily stem from a person’s individual preferences or personal beliefs and cloud their ability to make rational choices. Investors aren’t immune to such biases, and while some experienced investors may succeed in looking past their biases to make sensible investment choices, others may fall prey to incorrect decisions dictated by their biases.

Explained below are 10 common cognitive biases that affect investors of all kinds at some point in their lives.

  1. Information Bias

What it is – Information bias is the inclination to absorb and analyze every bit of information that comes your way, even when it has little to do with the investment options on your table.

Example – Ifyou’re interested in investing in a term insurance plan, but instead spend your time reading about unrelated options like travel or fire insurance, you run the risk of suffering from information bias.

  • Bandwagon Bias

What it is – Bandwagon bias refers to the practice of investing in a stock or scheme simply because most of the people are doing so. It’s the tendency to follow the crowd to fit in.

Example – A large segment of cryptocurrency investors are prone to bandwagon bias, causing them to invest in a currency simply because it seems popular. Many such investors have become victims of pump and dump schemes on account of this error of judgement.

  • Hindsight Bias

What it is – This bias is a double-edged sword that makes an investor see favorable outcomes in the past as predictable and unfavorable results as unpredictable. In most cases, a significant loss is more due to an error of judgement as opposed to unpredictability.

Example – When an investor blames the volatility of the stock market or an unpredictable crash for a sudden, substantial loss, they are, in all likelihood, suffering from hindsight bias.

  • Recency Bias

What it is – As the name obviously implies, a recency bias tends to make investors value the most recent information higher than the past news and experience. Although recent information appears fresh and more relevant, it may not always be the case.

Example – When looking up information related to their investment options online, people sometimes tend to filter out the data pertaining to the past year or the past six months. This can keep you from more relevant information that may be slightly older, causing you to make wrong decisions.

  • Confirmation Bias

What it is – Confirmation bias is one of the easiest misconceptions to fall prey to, because it means you only choose to look at information that confirms your own long-held views on an investment vessel. Anything that makes you question your belief is easily overlooked or dismissed.

Example – If you’ve always believed that it isn’t necessary to invest in child insurance, you’ll tend to skip over advertisements or emails that inform you about such plans.

  • Familiarity Bias

What it is – Familiarity bias means sticking with the feeling of safety that comes from remaining loyal to investment options you’re familiar with. This bias keeps you from moving out of your comfort zone and diversifying your portfolio.

Example – As an investor, if you’ve always held stocks of a specific group of domestic companies, you may find it tough to diversify and invest in other stocks even when the companies you’re familiar with are making losses.

  • Loss-aversion Bias

What it is – Nobody likes to lose. But if you dislike losing so much so that it spurs you into inaction as opposed to action, you’re probably suffering from loss-aversion bias.

Example – After they’ve suffered a substantial loss, traders sometimes refrain from reinvesting in equity or options for as long as a month or more.

  • Restraint Bias

What it is – Investors often run the risk of overestimating their ability to restrain from the possibility of temptation, especially when an investment looks lucrative. Despite having the tightest checks in place, even the best investors aren’t as restrained as they would like to believe.

Example – Every investor has their own set of brilliant investment ideas. And when one of these works repeatedly, sending them on a winning streak, they tend to overindulge and take rash decisions.

  • Anchoring Bias

What it is – Anchoring bias means that you tend to latch on to the first seemingly logical piece of information that you come across when you’re making investment decisions.

Example – If you’re researching the best stocks to invest in this year, you may tend to go with the first article that lists out a few stocks. This bias prevents you from learning more and gathering all the information necessary to make informed decisions.

  1. Oversimplification

What it is – Not all information needed to make investment decisions can be simplified. Some concepts are complex by nature, and the only way to understand them is to research the details. Oversimplification is the tendency to look only at the aspects you can comprehend and pass over the parts that appear complex.

Example – ULIPs are hybrid insurance plans that combine both life insurance and market-linked investments. Potential investors who find the concept slightly complex may pass it over, deeming it as an unnecessary investment, or oversimplify the concepts and thus, remain unaware of some details.

Investment doesn’t merely refer to equity or stock options. Insurance is a kind of investment as well, and competent insurance companies list out all the salient features of their investment options on their website. Aegon Life, for instance, has listed out all the key features, benefits, testimonials, FAQs, and guidelines of its term insurance plans on its website. This helps potential investors steer clear of common biases that they may be susceptible to. To know about Aegon Life’s life insurance products like health insurance and other products, visit our home page.


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