When it comes to investing, we focus on the market and the economy. But there’s another factor that could be having a big impact on your returns: you. At Insight Wealth Planning, we’ve seen how psychological biases can kill even the best-laid investment plans.
Behavioural Finance
Research in behavioural finance has shown that our mental shortcuts and emotional responses can lead to systematic errors in investment decision-making. These biases work beneath our conscious awareness and affect our choices even when we think we’re being completely rational.
Let’s look at the five most common psychological traps that might be holding back your investment performance:
1. The Confirmation Trap
We all love being right—sometimes too much. Confirmation bias means we seek out information that validates our existing investment choices and ignore contradictory evidence. Have you ever scrolled past negative news about a stock you own? That’s confirmation bias at work.
2. The Overconfidence Illusion
Many investors fall into the trap of overestimating their ability to predict market movements or pick winning investments. This overconfidence leads to excessive trading and unnecessary transaction costs that eat into returns. Remember: even professional fund managers can’t consistently beat the market.
The Loss Aversion Puzzle and Investment Risks
Behavioural economists have found that the pain of losing money is psychologically twice as powerful as the pleasure of gaining the same amount. This bias keeps investors holding onto underperforming investments for far too long, hoping to break even rather than making the rational decision to cut losses and move to better opportunities.
4. The Anchoring Effect
Just as an anchor holds a ship in place, our minds get anchored to specific reference points—usually the price we paid for an investment. This anchoring bias prevents us from objectively evaluating new information and adjusting our strategy when the market changes.
5. The Herd Mentality
Warren Buffett said to “be fearful when others are greedy and greedy when others are fearful”. But many investors do the opposite, following the crowd into popular investments at peak prices and panicking during market downturns. This herding behaviour leads to buying high and selling low—exactly the opposite of investing.
Your Financial Goals
Understanding your financial goals is the first step to creating an investment plan. Your financial goals can be short-term, medium-term, or long-term and will vary depending on your age, income, and personal circumstances. Common financial goals include saving for retirement, buying a house, funding a child’s education or building wealth.
To understand your financial goals, you need to assess your current financial situation, including your income, expenses, assets and debts. You should also consider your risk tolerance, investment horizon and expected returns on investment. Once you have a clear understanding of your financial goals, you can start developing an investment plan that matches your objectives.
Investment Risk
Investment risk is part of investing, and it’s important to understand and manage it to achieve your financial goals. There are several types of investment risk, including market risk, credit risk, liquidity risk and inflation risk. Market risk is the risk of losses due to market fluctuations, credit risk is the risk of the borrower defaulting, liquidity risk is the risk of not being able to sell an investment quickly enough or at a fair price and inflation risk is the risk of losing purchasing power due to inflation.
To manage investment risk, you can diversify your investment portfolio across different asset classes, such as stocks, bonds, mutual funds, and real estate. You can also consider hedging strategies—options or futures contracts—to reduce potential losses. You can also adjust your investment portfolio regularly to make sure it stays aligned with your financial goals and risk tolerance.
Breaking free from Behavioural Biases
Good news? Once you know what these traps are, you can overcome them:
Self Awareness of Financial Goals
- Learn to recognise your money and investing triggers
- Practice mindful decision-making by questioning your first thoughts
- Keep an investment journal to track your decisions and the reasons behind them
Create and Follow an Investment Plan
- Set clear investment goals and risk parameters
- Rebalance regularly
- Use automation to remove emotion
Widen Your View
- Seek out opposing views on your investments
- Get multiple data sources before you decide
- Question your own assumptions
Regular Asset Allocation Reviews
- Quarterly portfolio reviews
- Are your investments still aligned with your goals?
- Adjust for life changes and market conditions
Diversified Investment Portfolio
Building a diversified investment portfolio is key to managing risk and achieving your financial goals. A diversified portfolio should have a mix of different asset classes—stocks, bonds, mutual funds and real estate. The key is to spread your investments across different asset classes to reduce losses and increase gains.
When building a diversified investment portfolio, you should consider your financial goals, risk tolerance and investment horizon. You should also consider the fees and expenses of each investment and the expected returns. You can also consider working with a financial advisor or investment professional to help you build a diversified investment portfolio.
Common Investment Mistakes
There are several common investment mistakes that can derail your financial goals. One of the biggest mistakes is not knowing your financial goals and risk tolerance. Another is not diversifying your investment portfolio, which can increase losses and reduce gains.
Other mistakes include not reviewing and adjusting your investment portfolio regularly, not considering fees and expenses, and not having a long-term perspective. To avoid these mistakes, you should take the time to know your financial goals and risk tolerance, diversify your investment portfolio and review and adjust your investments.
Stay Informed and Focused
Staying informed and focused is key to achieving your financial goals. Review and adjust your investment portfolio regularly to make sure it’s aligned to your financial goals and risk tolerance. Stay informed about market trends, economic conditions, and changes in tax laws and regulations.
To stay informed and focused, you can work with a financial advisor or investment professional who can give you personalised advice and guidance. You can also attend investment seminars or workshops, read investment books or articles, and follow reputable investment websites or blogs. You can also set clear financial goals and track your progress regularly to stay motivated and focused.
Value of Professional Guidance
At Insight Wealth Planning, we know managing behavioural biases isn’t easy, and even experienced investors fall into these psychological traps. That’s why working with a qualified Financial Adviser can be so valuable. Don’t let behavioural biases ruin your financial future. Get in touch with us today to find out how we can help you build and maintain an investment portfolio that’s robust to time and human nature.