Investors’ Most Common Behavorial Biases
3 years ago JCprojectfreedom 0
Status Quo Bias
The investors been in a comfort zone will not be willing to do anything to change their present situation. For example, investors are willing to put their excess cash into a saving account and not willing to use them to invest in stocks and bonds as this results in a change to their present situation.
Status Quo Bias not only apply to investors, it can affect analysts as well. When there is new information in the market, the analysts need to re-evaluate their previous coverage which is tedious and takes time and effort. They will rather remain status quo which is the easy way out.
The investors did not have sufficient information, their vision is clouded and restricted. This framing will not allow the investors to have a helicopter view of the investing landscape. The investors will not be able to look for substitute products and obtain other information.
Investors tend to assess a product based on short-term investment period and did not analyse how long this situation will last and whether there are better alternatives. Investors tend to have home biasedness which is a view that local products are better than the rest of the world. For instance, a local investor will have a larger composition of Singapore shares in their portfolio. This perspective may limit their return and does not allow a better diversification with other products.
Investors will be influenced by present information based on what they read and hear and not based on information such as fundamental analysis to analyse the situation. For instance, if the investors are bombarded by daily news of huge dip in stock prices, they will be frozen in their paths and not enter the market. Warren Buffet quoted on “Be Fearful when Others are Greedy and Greedy when Others are Fearful”, this is to remind investors not to follow the crowd and need to remain rational with an unbias vision.
Investors tend to believe in what they want to believe in. For instance, when an investor is reading an analyst report, if he wants the share price to increase, he will look for information in the report which will support his belief. If he hopes that the share price will drop, he will look at the negative news to reinforce his belief.
Sunk Cost Error
When a particular stock is not performing and the investor is in the red with it, the investor may not have come to terms with this and change his focus to the next better opportunity. Investors should learn to cut loss and move on to the next opportunity . He should not be affected by the sunken cost. If the investor does not cut loss and switch to another opportunity, he can lose out on other opportunities which will more than make up for the loss.
It is advisable for the investors to have a checklist to remain rational at all times.
- Collect information which is contradicting with your view => to help you be a contrarian
- Looking at your investment window, is your investment strategy affected by news in the market?
- Before you make a major decision, you need to ask yourself under normal circumstance what will you do?
- What is the reason to hold the stock when the price is dropping? Is it due to price or future potential earnings? Ask yourself, will you buy more of the shares now?
- Discipline is important, you need to monitor your personal balance sheet to understand what you can or cannot lose.