Behavioral Bias Cognitive Vs. Emotional Bias in Investing 5.00 / 5 (100.00%) 1 vote

When it comes to investing, the investors state of mind can make all of the difference in his profit outcome. While investing is often based on historical data and rational decision making, an investors outlook can also play a role. Figuring out some of the biases that most investors face will help to understand how the state of mind can affect profits in investing.

Behavioral Bias Cognitive Vs. Emotional Bias in Investing

Behavioral bias Cognitive vs. Emotional Bias in Investing

Confirmation Bias

Instead of gathering all of the facts and information to assess a situation, confirmation bias often causes us to come to a conclusion first, then only consider facts that confirm our conclusions. This happens often in investing, as investors will hedge their bets on a certain stock, then ignore evidence that the stock is struggling.

In the inverse, there are people who refuse to invest in certain vehiclesblue chip stocks, real estate investment trusts and muni bonds, for exampledespite their historical performance records. Confirmation bias is one of the major psychological factors that affect investment outcomes.

Optimism Bias

Everyone is an expert and every hunch is a sure thing when it comes to optimism bias. Optimism bias occurs when a persons confidence in their abilities exceed their actual abilities. A person may believe that their judgment in picking the right stock is spot on, while their outcomes suggest something entirely different.

Optimism bias explains why 90% of drivers rate their skills as above average, but actual studies find that those rates are drastically inflated. Venture capitalists often predict that their businesses will perform better than they actually do, causing investors to make decisions based on false information.

Self-Serving Bias

This bias makes us believe that everything good that happens to us is based on our own actions, while bad things that happen are due to factors outside of our control. This happens often with investors who believe that their stock profits are due to their expert picks, while falling profits are due to a weak economy or incompetent broker.

Loss Aversion

Loss aversion is one of the most common behavioral biases in investing. Many would-be investors never get in on the game because of the fear of loss. Most people feel losses more strongly than they do gains. This causes investors to overreact in response to a loss, selling low and losing profits. Loss aversion causes investors to make bold predictions but remain timid when it comes to actual actions.

Choice Paralysis

Often called analysis paralysis, this occurs when we have too many options at our disposal. People often operate better when they have fewer, rather than more choices. Too many choices can cause a person to not make any choice at all.

When it comes to investing, the psychology of the investor plays a huge role in the outcome of profits. From fear of loss to confirmation bias, understanding how these traits operate is an effective way to make the right financial decisions each time.