We as humans are subject to behavioral, cognitive and emotional biases, but the next time you decide to change something in your portfolio take a step back and make sure you aren’t falling into one of these traps.
The five most common cognitive biases, according to Visual Capitalist:
- Anchoring: The anchoring bias describes our tendency to rely heavily on the first piece of information received. An example would be headline risk, when a not-so-positive headline hits the news and investors dump a stock without digging through the potential implications.
- Recency: Recency bias is putting more emphasis on recent information, given that it is top of mind. This is where taking a wider view and looking back at past events can help.
- Loss Aversion: This bias can occur with individuals who prefer avoiding losses to acquiring gains. They would rather avoid a loss of $10 than have a gain of $10. This results in stops that are too tight or inaction when things sell off, as they hold on for a recovery that may or may not ever come about.
- Herding Mentality: The herding mentality bias is a result of investors placing emphasis on the collective actions of others vs. their own private information. The example would be piling into the FANG Stocks (Facebook, Amazon, Netflix and Google) in 2015 and 2017.
- Confirmation: Confirmation bias is exhibited by investors when they search for and rely on data that supports their thesis without taking into account evidence that contradicts them.
These are just a few of the many biases that could impact your portfolio. We urge you to be diligent and stick to your plan in order to mitigate the potential to fall into one of these traps.
