How to use Investor Psychology to make the most of your investment

In investing, the name of the game is risk. So, it’s unsurprising that emotions and psychology play quite a substantial role from the backseat of an investor’s mind.

Behavioural Finance is the study of how psychology, including biases, influences our approach to investing. So how can you use an understanding of these biases to potentially help make the most of your investment?

What are behavioural finance biases?

A bias is an automatic positive or negative prejudice, feeling, or opinion. You might not even be aware of a bias that you have. Behavioural finance biases can impact the way an investor makes choices about their money and investment.

Here’s what to look out for

Let’s take a look at some of the most important biases to watch out for before you start investing.

Survivorship Bias

Only focussing on what has been successful and overlooking what has not.

How it affects investors: An investor with this bias might have a difficult time looking at the bigger picture with both positives and negatives. For example, this investor might want to invest in a company that recently had a very positive performance. But, recent growth does not mean that the company’s stocks will continue to go up.

Overconfidence Bias

The belief that one knows more and/or has better judgment than everyone else.

How it affects investors: This can lead to unnecessary levels of risk, and in some instances even a belief that an individual can “beat” the market. For example, buying a share with the aim of quickly selling to make a profit, rather than leaving your investment for the suggested minimum of 5 years.

What is a heuristic in psychology?

Heuristics are mental shortcuts that help us solve problems. Heuristics and decision making go hand-in-hand. They’re meant to help us simplify, speed up, and reduce the l effort it takes to make a decision.

Availability Heuristic

Reliance on thoughts and examples that come to mind straight away. This might be mentioned often, or perhaps something from memory that was particularly positive or negative.

How it affects investors: You might not fact-check or analyse all the information available. This can lead to bad judgments and mistakes in investing.  An example is where your friend has made a substantial profit from a certain type of investment, you may overlook information showing a significant number of people made losses with that investment.

Loss Aversion Heuristic

People tend to feel losses twice as badly as they appreciate gains.

How it affects investors: An investor might be hesitant to invest for the long run if they see a dip in value. In this case, the investor might miss out on a profit if the value increases over time.

How to overcome these heuristics and biases

Let’s get to the good part: How to make these heuristics and biases work for you.

The answer is simple. Talk to expert financial advisors to find an investment that is right for you. They can help you avoid falling into a bias or heuristic trap and find the best investment to suit your financial goals. Read up on the Secret Sauce to Investing for more information on what you can do to make the most of your investment.

Or, if you’re ready to start investing online with expert help today, check out Smart Invest.