Many of us make sub-conscious financial mistakes in our daily lives, such as thinking that something must be a steal just because it?s on a 50% discount right now (this is the anchoring effect at play).
What?s really unfortunate about the sub-conscious mistakes we make – which are also known as behavioural biases – is that they come into play when we invest in the stock market too. There are many behavourial biases that can hurt our investing returns, but let?s turn our attention to three of them in particular.
1. The gambler?s fallacy
Many of us make sub-conscious financial mistakes in our daily lives, such as thinking that something must be a steal just because it’s on a 50% discount right now (this is the anchoring effect at play).
What’s really unfortunate about the sub-conscious mistakes we make – which are also known as behavioural biases – is that they come into play when we invest in the stock market too. There are many behavourial biases that can hurt our investing returns, but let’s turn our attention to three of them in particular.
1. The gambler’s fallacy
Imagine yourself in a casino playing the game of blackjack. The dealer shuffles the cards, and you place your bet. To your dismay, you lose one hand, then two, then three, and finally a fourth.
In that instant, you may think to yourself: “Since I’ve lost four in a row, I should be due to win the fifth.”
But statistically, how often you have won or lost in the previous rounds does not affect your future outcomes. The stock market functions in the same way. For example, just because a stock has been falling does not mean that it is guaranteed to turn around and increase in value in the future.
2. The “House Money” fallacy
Let’s take a look at the aforementioned casino scenario one more time. Imagine walking in with $2,000 and then winning $3,000. Many people would regard the $3,000 as the “house’s money” and tend to be more reckless when betting with that capital.
In the stock market, some investors who have unrealized gains from their investments may take more risk thinking that they are now “in the money.” What these investors fail to notice is that every dollar they have in the stock market is their own regardless of whether it is their initial invested capital or unrealised gains they have enjoyed from a stock.
3. The self-attribution Bias
This bias describes the tendency for people to attribute successful investment outcomes as a result of their own research analysis while blaming negative outcomes purely to forces beyond their control
This bias can be dangerous as it may result in the investor making poor decisions continually over the long run, as they will not actively recognize and learn from the mistakes they have committed in the past.
Behavioural biases are pernicious because they often occur sub-consciously. It’s not something we can simply will away. But there are corrective steps we can take – and the very first step is simply being aware that we humans, as a whole, are susceptible to behavioural biases.
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