But What If You've Been Gaslighting Yourself?...

Have you ever found yourself making a financial decision that, in hindsight, didn't seem logical? Welcome to the fascinating world of cognitive biases! Cognitive biases are ways we process and interpret information (often in error) that influence the way we act. Basically, our brains gaslight us, leading to choices that might not always be in our best financial interest. It can happen even among the most savvy investors.

Picture this: you're at a crossroads with your investments. You’ve got all the data and expert advice you need, yet somehow, you make a decision that doesn’t match the best (or smartest) option. What's happening here? This is where cognitive biases come into play. They mess with our judgment, pushing us to make decisions based on emotions, gut feelings, or outdated information rather than solid financial principles.

Let’s dive into three common cognitive biases—loss aversion, confirmation bias, and anchoring—and see how they might be affecting your investment choices.

Loss Aversion: The Fear of Losing

Imagine you’re at a casino. You win $100, but then you lose $50. How do you feel? Most people would feel the sting of that $50 loss more intensely than the joy of the $100 gain. This is loss aversion. In investing, this bias can lead you to hold onto losing stocks for too long, hoping they’ll rebound, or to sell winning stocks too early to “lock in” gains.

Real Life Example: During the 2008 financial crisis, many investors held onto their plummeting stocks, hoping for a rebound that never came. This was a classic case of loss aversion. Investors were so averse to realizing losses that they ended up with even greater losses as the market continued to decline¹.

Confirmation Bias: Seeing What You Want to See

Now that the presidential election is in full swing, you’ve probably noticed how voters tend to seek out information that supports their candidate or political beliefs. That’s confirmation bias. If you believe a particular stock is a winner, you might only pay attention to positive news and ignore the red flags. This can lead to overconfidence and poor investment decisions.

Real Life Example: In the late 1990s, during the dot-com bubble, investors were overly optimistic about the potential of internet companies. Many ignored warning signs and negative information, focusing only on the positive news that confirmed their belief in the tech boom. When the bubble burst in 2000, many investors faced significant losses².

Anchoring: Stuck on the First Number

Anchoring is the tendency to rely too heavily on the first piece of information you receive. For example, if you hear that a stock was once worth $100, you might anchor to that number, even if the stock’s current fundamentals don’t support it. This can lead to unrealistic expectations and poor investment choices.

Real Life Example: Before the 2008 housing market crash, many homeowners and investors anchored to the high property values from the peak of the market. They believed that housing prices would continue to rise or at least return to their previous highs. This anchoring led to unrealistic expectations and poor investment decisions, contributing to the severity of the crash³.

Now that you know your brain is literally wired to work against you at times, what can you do? There are a few actions you can take to prevent yourself from allowing these cognitive biases to impact your financial decisions:

Diversify Your Sources: Don’t rely on just one source of information. Seek out diverse opinions to get a well-rounded view.
Set Clear Goals: Define your investment goals and stick to them. This can help you stay focused and avoid emotional decisions.
Consult a Financial Advisor: Sometimes, an outside perspective can help you see past your biases and make more rational decisions.

Understanding and mitigating these cognitive biases can help you make smarter, more rational investment choices. Remember, even the wealthiest investors can fall prey to these mental traps, but with awareness and strategy, you can outsmart them!

If you’re interested in learning more about cognitive biases and how to avoid them, contact me at jennifer.jenkins@bluestonewp.com to schedule a consultation. Let’s work together to build a strategy that aligns with your goals, helps you navigate the complexities of the financial world, and helps you make more informed decisions with confidence!

References

¹Simply Psychology. (n.d.). Cognitive bias. Retrieved from https://www.simplypsychology.org/cognitive-bias.html

²Visual Capitalist. (n.d.). 50 cognitive biases in the modern world. Retrieved from https://www.visualcapitalist.com/50-cognitive-biases-in-the-modern-world/#google_vignette

³Scribbr. (n.d.). Cognitive bias. Retrieved from https://www.scribbr.com/research-bias/cognitive-bias/