When you’re watching your exchange traded funds (ETFs) or other investments dramatically depreciate, it becomes hard to control your emotions. Emotions are especially heightened now, after an especially tough period in the markets.
By controlling our emotions, we are able to grapple with the risks and make more logical decisions. The field of behavioral finance tries to answer why a set of psychological biases affect investment decisions, reports Veronica Dagher for The Wall Street Journal. Biases often occur because of excitement or fear, and it could led to investment moves that are illogical.
What are some biases to look out for?
- Anchoring bias. People develop attachments that can be irrational, and these attachments can include investments. A sign that you might have this attachment might be when you’re holding on to assets longer than they should on news of a single piece of information or on hopes of the investment reaching a magically high number.
- Recency bias. This occurs when you believe events or patterns of the past will occur exactly like they did again. Memories of loss or prosperity usually push this type of investment decision.
- Loss aversion bias. When the market keeps dipping lower and lower, you keep holding the investment and not acknowledge a loss until they sell. But you’re losing on two fronts in this scenario: your position is losing, and you’re not in another position that could potentially be moving higher, not lower.
- Endowment effect bias. We often take comfort in the familiar. This also holds true with investments in which you hold stocks in large, familiar companies and ignore other stocks or sectors. The investor would then assign a greater value to what they own over what they don’t.
- Overconfidence bias. If you trade too much and manage a portfolio on a stock-by-stock basis in an attempt to beat the market, you usually don’t.
How can we overcome these biases? It is best to take advice, especially from professional investors who use specific criteria to choose investments. It’s also important to not just have a strategy, but to stick to it without fail. By waiting for the market to signal what your next move should be, instead of your heart, you’ll be on the path to becoming a more successful investor.
Max Chen contributed to this article.