Crorepati Dreams? Recognize these 8 behavioural biases to build lasting wealth

Investors who suffer from self-attribution bias tend to attribute successful outcomes to their own actions and bad outcomes to external factors. They often exhibit this bias as a means of self-protection or self-enhancement.

According to a survey conducted by the CFA Institute, herding was identified as the topmost bias affecting investment decision-making, garnering 34% of the votes from 724 practitioners worldwide.

This indicates that herding is a prevalent bias. It is the phenomenon where investors follow what others, rather than their own analysis and risk appetite and therefore feel the fear of missing out.

Investors often chase past performance of stocks with the mistaken belief that historical returns predict future investment performance. Research evidence demonstrates that in such scenarios, investors do not benefit because performance typically fails to persist in the future.

To avoid this bias, investors should resist following the herd or jumping on the bandwagon.

People do not treat gains and losses in a linear way. They tend to remember losses more than the gains that were made. For example, it feels better to not lose Rs1,000 than to gain Rs1,000.

This bias was particularly evident during the COVID-19 crisis when many frightened investors sold their assets in a herd, leading to a significant market downturn.

This describes the tendency to prematurely sell stocks that have increased in value since their acquisitions while retaining stocks that have declined in value for an extended period.

The disposition effect is harmful to investors because it can increase the capital gains taxes that investors pay and can reduce returns even before taxes.

Confirmation bias occurs when investors favour information that confirms their pre-existing beliefs and ignore information that contradicts them.

Some investors have preconceived notions about stocks before they even start to look at the numbers. This can cause them to have blinders on and become a victim of confirmation bias.

Familiarity bias occurs when investors prefer to invest in familiar assets, such as domestic stocks, rather than diversifying their portfolios. This bias can lead to suboptimal investment performance due to a lack of diversification.

Many Enron employees invested their 401(k) retirement plans heavily in Enron stock. When Enron collapsed, they lost both their jobs and their savings.

Recency bias, also known as availability bias, occurs when investors give more weight to recent events and information, leading to skewed decision-making.

This bias can cause investors to make irrational decisions based on recent market trends rather than long-term data.


(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)