6 Common Investor Biases That Can Influence Your Investment Decisions To succeed in investing, avoiding and minimizing the impact of personal biases is crucial.

All of us develop certain biases based on our unique life experiences. These biases can be specific ideas or notions in various aspects of our life. And investing is nothing different. For instance, in middle-class households, equity has been compared with gambling. Due to this bias, many in our parents' generation invest only in FDs, even as they get subdued returns.

Similarly, several other biases often prevent investors from reaching their goals. This article will discuss the six most prevalent biases and how we can overcome them.

Contrast bias

We often tend to compare and associate a current situation to a similar situation that had occurred earlier to draw parallels. It is a common bias often exploited by real estate agents. They may initially show you a few inferior options before showing you the property they want to sell. This way, contrast bias would make the final property seem like a better deal than the ones shown earlier.

This same contrast bias is one of the key reasons investors get interested in stocks at their 52-week lows.

The best way to manage contrast bias is to think of the absolute value of an asset instead of making a relative comparison.

Consistency and commitment bias

When starting your investment journey, one bad experience can lead to a consistency and commitment bias. For example, a new set of investors come to the markets every time there is a bull run. They invest based on tips. But as the cycle turns, they lose money. And after that, they never look at direct stocks.

This particular kind of bias takes a lot of time to form. Once the investor starts believing certain things, he stays true to them, irrespective of whether the decision is correct.

One way to deal with this is to objectively analyse each investment idea and see if it holds merit.

Incentive bias

Rewards can have a significant influence on human behaviour. And that is the root cause of incentive bias. Here's an example.

Suppose you want to buy an endowment plan where the annual premium is INR 60,000. The agent told you he would return INR 40,000 commission in the first year. It will obviously incentivise you to purchase the endowment plan even if the returns are poor.

How to deal with it? Investors need to analyse each investment product and understand it correctly.

Social proof bias

This bias stems from the fact that people think that decisions taken by
the majority are always correct.

For example, when markets are in a bull run, you will see everyone around you investing in stocks and making money. As a result, many investors start investing in stocks without doing homework. They desperately want to make money because they feel everyone around is
making tons of money.

To reduce the impact of social proof bias, you can opt for two methods.

The first method is to create a checklist to help you determine if the majority view or the contrarian (minority) view is correct regarding an investment option.

Alternatively, you could develop a habit of seeking out specifics regarding why a specific investment is favoured. Knowing the root cause can help you determine the appropriate course of action.

Liking bias

All of us like some products over others. It can lead to a bias where we often overlook the shortcomings of the products we like.

For instance, many new investors stick to one or two specific stocks during a market rally after they have found success with them. They invest all their money in the stock during the rally. When markets correct, most of their investments are wiped out.

In 2008, many people invested in real estate stocks amid the market rally. But when the global recession hit the market, they lost 70-90 per cent of their investment value. Similarly, many companies added '.com' and '.net' to their names during the dot com boom. They could be in manufacturing or real estate, but adding dot com made investors perceive them as tech businesses, and their stock prices rose.

How can one deal with this kind of bias? Instead of evaluating stocks based on emotions or personal likes and dislikes, one should use analytical skills and tools.

Authority bias

It's the bias where people blindly follow the instructions of figures in authority, like market experts and analysts. Given that there are now many self-proclaimed stock market experts blindly following their recommendations might do more harm than good. To overcome this bias, consider a second opinion or ensure that the source of the advice is a competent individual.

Bottomline

To succeed in investing, avoiding and minimizing the impact of personal biases is crucial. After all, as John Bogle, the father of index investing said, "successful investing is doing a few things right and avoiding serious mistakes."