Investors seek to make rational, well-informed decisions regarding their investments. But no matter how logical they try to be, biases often creep in. These biases are particularly pronounced in times of stress or uncertainty, driving market volatility and leading to poor investment outcomes.
To paraphrase the great investor Howard Marks, co-founder of Oaktree Capital, most of the time the real-world environment is either pretty good, or not so hot, but markets price flawless or helpless – and swing wildly between the two.
Behavioural biases are a natural part of human behaviour, but they can cloud judgment and trigger emotional decisions that can potentially sabotage financial success. Learn to overcome them however and you can become a more confident and potentially successful investor.
This article isn’t personal advice. Remember, investments rise and fall in value, so you could get back less than you invest. If you’re not sure if an investment’s right for you, ask for financial advice.
Anchoring Bias – when the past impacts investment decisions
Anchoring bias happens when investors fixate on a past reference point and fail to adjust expectations as conditions change. A notable example of this is when Royal Dutch Shell announced a 66% dividend cut in 2020, the first in almost 80 years, due to falling oil prices and the pandemic.
For years, Shell’s 6–7% dividend yield served as a mental anchor for income investors and pension funds, providing a sense of stability even as its fundamentals weakened.
When the cut came, many were surprised not because warning signs were absent, but because expectations were tied to history rather than present reality. To avoid such bias, regularly step back from your portfolio, review the fundamentals and assess whether they remain true to your investment case. View events as cues to reassess long-term value.
Loss Aversion – why investors hold on to long
Research shows that people feel the pain of a loss about twice as strongly as they feel the pleasure of an equivalent gain. For instance, if your recent investment gained £100, you might feel a sense of satisfaction, but at the same time, losing £100 often feels significantly more painful in comparison.
This is why many investors refuse to sell a losing stock, hoping it rebounds, even when the smart move is to cut losses and move on. This is known as loss aversion, and if left unchecked, it can seriously impact your long-term returns.
That said – do not confuse loss aversion with the “flight” instinct to run from falling markets. What is key here is to separate investment specific challenges – a manager change on a fund or trust, a company that has lost its competitive advantage – from transient market or economic activity. The former should not be ignored for investment success, the latter should.
Herd Mentality – FOMO in financial markets
This is the classic case of fear of missing out (FOMO) in action, which often drives investors to chase the latest trends, worrying they’ll be left behind if they don’t jump on the hype train.
Artificial intelligence (AI) stocks, gold and silver, and defence companies have benefited from momentum in recent years, as investors piled in following strong performance, with hopes of these returns being repeated in the future. However, this herd mentality often leads to investing in overvalued investments or companies, with the decision to do so driven more by hype than fundamentals. Just because everyone is buying a stock or sector doesn’t make it a good investment.
To avoid this bias, focus on building a diversified portfolio across sectors. When tempted to buy into an investment that has already performed strongly, block out the noise and rely on the true signals that indicate performance drivers.
Before investing, ask yourself – “Would I make this decision if no one else was talking about it? Does it add something different to my portfolio? Does the risk match my goals?”
If you can overcome fear, greed and FOMO you’ll make a better investor for it.