Bruce Miller, MBA
Vice President, Arista Wealth Management
Simply thinking about your investments can sometimes be overwhelming. We all want to make financially healthy decisions, but sometimes various biases keep us from accomplishing our goal. This 3-part series will reveal how you may be sabotaging your own plan.
In many situations, especially when overloaded with information, people use heuristics, or mental shortcuts, to help them make decisions. By using a “rule-of-thumb” approach, you rely on past experiences to help solve complex problems.
But when it comes to financial decisions, using mental shortcut experiences doesn’t always lead to wise decisions. Past assumptions Heuristics can produce biases, which could negatively affect your investment decisions.
Mental Shortcut Biases Clutter Your Financial Mind
Unlike machines, we are not always able to make decisions objectively; we are vulnerable to emotional, cognitive, and social factors as well as childhood and personal experiences.
This clutter causes biases which I will outline in three distinct group over the next three weeks:
- Emotional-based biases
- Social-based biases
- Cognitive-based biases
As you read each section, ask yourself: are any of these biases causing a problem in my investment decisions?
Biases Based on Emotions
Many times, emotional biases are instinctive and involuntary; you may not even be aware that they are affecting you. However, it can distort your investment decision-making abilities.
Mood plays a significant role in creating emotional biases which include:
- The disposition effect is tied to your mood—you want to feel pride and avoid regret about your financial decisions. This may cause you to buy things that have done well and sell things that have done poorly—leading to buying high and selling low —thus forgetting historical long-term market gains.
- Anchoring-and-adjustment technique will allow you to avoid the pain of experiencing a loss in your investment. Normally, this is when you compare your reference point value or price to a current price, without adjusting sufficiently to new information.
- Optimism bias is the tendency to be positive about investments when you are in a good mood. This bias leads to an irrational line of reasoning in which you think that losses only ever happen to other people, not you.
Next week we’ll continue the review of emotional-based biases as well as take a look at social-based biases that many investors are prone to.
Meanwhile, we are here to help you avoid making costly misjudgments. If you have any questions, please call or email our office to schedule an appointment.
Bruce Miller is an Investment Adviser Representative of Arista Wealth Management, LLC, a Registered Investment Adviser
*Bruce Miller condensed this article originally produced by Advicent Solutions, an entity unrelated to Arista Wealth Management. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. Arista Wealth does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues.
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