Slideshows | April 5, 2012

Eight common thinking traps for investors

When it comes to investing, thinking traps can skew the way people behave.

I'll do what they're doing
Overconfidence, loss aversion and other behavioural biases can influence many aspects of investing, including the timing of buying and selling - and what we actually decide to invest in. Herd behaviour can be a powerful force, as can the influence of fresh information in the availability bias.

Eight traps explained
Hindsight bias is when an outcome seems obvious when we look back. It may sound harmless but it can actually encourage a view of the world as more predictable than it is – dangerous ground for investors. Our slideshow explains eight of these common traps for investors.

 

1

“I knew it all along”

Hindsight bias is when an outcome seems obvious when we look back. It may sound harmless but it can actually encourage a view of the world as more predictable than it is – dangerous ground for investors.

2

“I’ll do what they’re doing”

Our tendency to follow the crowd is known as herd behaviour and it can influence decisions to invest in housing, specific shares and more. Crowds can be wise but they can also push prices unsustainably high – and it is hard to know which is true at crucial points in time.

3

“Great – that’s exactly what I want to see”

Confirmation bias is seeking information that agrees with what we want to hear. An example is a house buyer who selectively interprets statistics to back up the decision to buy.

4

“I’ll be right”

Overconfidence can lead people to overestimate their knowledge and ability to predict events and can lead them to underestimate risk. But it has two sides: such as overconfidence helping create new businesses but costing if the ventures fail.

5

“I can’t bear selling right now”

A deal has gone sour yet we stick with it to avoid the pain of realising a loss. Known as loss aversion, it can mean ultimately losing more money if shares, property or other assets continue to plunge until the investor decides to take the hit.

6

“I read in the newspaper today …”

Recent or very vivid information can influence the way we invest – and we can overreact to it because it is fresh in our minds. Known as the availability bias, buyers who snap up housing after being urged to “get in quick” may be falling for the thinking trap.

7

“I want it now”

Would you choose a holiday now or a more comfortable retirement? Hyperbolic discounting is our tendency to consider the consequences of our choices less the further in the future they fall. For important future events – such as retirement – it can have big implications.

8

“Let’s do it later”

Procrastination is one of the main problems associated with the amount people save. So as tempting as it is to put off organising personal finances, block out time in your diary regularly to set money goals and monitor progress towards them.

BiasPeer effectsProcrastinationOverconfidenceHyperbolic discounting

eZonomics team
.(JavaScript must be enabled to view this email address)

Have your say

Do you generally carry cash?