In 1953, De Beers ran a hugely successful marketing campaign to promote its diamond engagement ring. It used the strapline “how else could a month’s salary last a lifetime?”

The success of the campaign relied on the biases we have as humans, which are used to make decisions. In the case of the advert, it was the cognitive bias of anchoring, which is when we rely heavily on a single piece of information to decide.

In this case, the piece of information was that we should spend month’s salary when buying a diamond engagement ring.

Anchoring is one of many biases we use when making decisions in every aspect of our life, so it will come as no surprise to learn they could play a part in investment decisions. That said, while biases may work in favour of marketeers, they might hinder you when managing your wealth.

Read on to discover 10 common biases, and how they could stop you making the right investment decision.

There are two types of bias

While they work in very different ways, both can lead to you making a decision you later regret. These are:

• Cognitive bias: when you make a decision based on a pre-conceived idea or established concepts. This means a decision could be made based on the way you have interpreted information.
• Emotional bias: this is where a decision is based on your feelings at the time. This means it might be a knee-jerk reaction to a situation which you later regret.

Read on to discover 10 investment biases that you need to be aware of when investing.

Cognitive biases

Confirmation bias

As humans we tend to pay more attention to information that supports our pre-conceived ideas, which could be why you read the news service or newspaper that you do. This might mean you ignore opposing information, no matter how logical or compelling, because it does not match your own beliefs. This could result in you dismissing warning signs or opportunities that you should act on.

Familiarity bias 

This cognitive bias means you may be more likely to trust well-known investors, investment companies or even celebrities when making investment decisions. By concentrating on the familiar, you may miss opportunities or put your money into funds that may be “too good to be true”.

Herd mentality

Put simply, it’s where you could find yourself being influenced by the decisions friends, family, colleagues or the general masses are making. This could result in you making an investment you later regret, potentially at the expense of another investment you decide to ignore. While following the crowd can sometimes be the right thing to do, make sure it’s based on thorough research.

Recency bias

This is where decisions are based on recent events. For example, you might invest in a company that’s performed well recently, meaning you’re putting your money in just as the value’s about to peak – or worse, start to fall in value.

Over-simplification bias

This is when we try to understand complex issues by seeking simple explanations. As the world of finance and investments is complicated, you may be at risk of over-simplifying information and misunderstanding. This could mean you miss an opportunity or keep investments when it’s better to let them go.

Anchoring bias

As explained above, this is where you may rely too heavily on an individual piece of information or fact. Other examples could be when a share price was once being particularly strong, yet its overall trading performance is poor. This might mean you keep the shares despite suffering greater losses when you later sell them.

Emotional biases

Loss aversion

This is one of the most common emotional biases. As humans we tend to feel greater pain from a loss than the joy we feel from a gain, meaning you could make a decision just to avoid the discomfort associated with loss. This might be deciding to sell an investment when it’s losing value due to a downturn in the market, when keeping it could mean it recovers over the long term.

Endowment bias

This is where emotion means you might place more value on certain assets over others. This may mean you hold on to investments when the evidence suggests you shouldn’t, forgoing the opportunity to switch to others that could have greater growth potential or carry less risk.

Self-confidence

This could be particularly dangerous if you’ve enjoyed success with previous investments. As such, you may become overconfident, which could result in you not diversifying your investments enough and ignoring vital warning signs about your existing funds.

Regret-aversion bias

This is where you may put off a decision to prevent a potential mistake. This might mean you don’t invest or disinvest when you should, missing an opportunity for growth or to limit your losses.

A financial planner can help you side-step these biases

Having a second opinion from a professional who understands the world of finance and investing could significantly reduce the potential of falling foul of any of these biases.

A financial planner can explain what is happening with the markets and your investment, helping you understand your options and potential consequences of any decision.

If you like to discuss your situation, or have a financial decision to make, please contact us on 0800 434 6337.

Please note:

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.