In the 21st century we all want to claim to be open and objective, but as human beings, we often operate on cognitive biases. Cognitive bias is happening when we think in a certain way, that is not based on judgment or rational evidence. There are many types of cognitive biases but not all of them affect our biases in the same way. Still, scientists agree that cognitive biases highly determine the way we manage our money, relationships, management and entrepreneurship.
We are moved by our own biases every day even without knowing it and make decisions based on them. As not all decisions are equally important, we don’t focus on our biases. However, when it comes to financial investments we should definitely take our biases into consideration.
Here are 5 cognitive biases that can affect your financial decisions in a bad way.
- Endowment Effect
Endowment effect can be described as “sticking with what you have”. For example, let’s say that you own stocks of a popular company. At the moment, the price goes down and shows no signs of recovering in the nearer future, it would be wise to sell stocks. However, we appreciate what we have at the moment and hope for better future, rather than accepting a certain amount and having to live with the fact that the price skyrocketed the next day (in case it happens). Very often, people are completely unaware of this effect which can manifest in different ways. It is also possible to ‘try to get rid of’ a certain thing, but demand an unrealistic price because they don’t want to get rid of it.
- Confirmation Bias
Nobody likes to be wrong, right? That is why confirmation bias happens – human beings are always looking for evidence that supports their theories, strategies, and decisions. There is nothing wrong with being subjective, but confirmation bias makes us forget to take all important information into consideration which can lead to bad decisions in all aspects of life, not only finances or partnerships.
- Gamblers Fallacy
This bias is frequent among the gamblers (as the name indicates) as they believe their chances will change if they just play another game. Even if the odds are always 50/50 we humans believe that the positive outcome will happen sooner or later. This usually leads to forced trading and forced investments. After the profit is made, the person thinks they have been right all the time, but the losses are bigger than the profit, this can easily amass loss in CFDs trading – so select CFD brokers without negative balance.
- Overconfidence Bias
Self-confidence is great, but sometimes people think that their opinion is the only thing that matters as they value it above anything else. It is very hard to be objective about our own abilities and we often can’t see the limits of our own knowledge and capabilities. This bias can be easily avoided if we act upon information, and not our interpretation or impression, and approach the issue systematically.
Anchoring is probably the type of bias that is most commonly present. Often referred to as “first impression bias” is widely known as – jumping to conclusions. People usually make their decision based on the information they perceive early during the process and tend to neglect other solutions and information. Anchoring is often present when we have to make a decision quickly and the best solution is to take a deep breath and first think whether you should think this one through. Also, make sure to work on having more than enough time to make the important decisions.
Can We Control our Biases?
Some researches like Gigernezer and Haselton claim that we can learn to control our biases. The main way to control them is to avoid automatic processing of information and use controlled processing. Also, some researches showed that after participants acknowledged that they will truly be responsible for the results of their future decision (especially when related to money), that there are higher chances that bias will be avoided.