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Behavioural biases are unconscious beliefs or thoughts that can influence our decisions, sometimes with negative consequences. Without proper care they can affect even the most prudent investors, and they are more likely to appear during times of stress or uncertainty. Here we highlight five of the most common biases, and show you how we manage behavioural bias at Architas.
Loss aversion is a tendency to avoid losses, even if it means missing out on gains. It stems from the idea that humans reportedly experience the pain of a loss twice as intensely as the pleasure of an equivalent gain. A great example is pulling all of your money out of the stock market after a big drop, locking in losses and potentially missing out on a subsequent recovery.
This involves focusing only on information that confirms your beliefs, and ignoring any new data that might challenge them. If you feel positive about an industry, you might decide to invest after a good run of stock market performance, while overlooking poor earnings growth or upcoming regulatory challenges.
Recency bias encourages short term thinking. It causes people to place undue importance on recent events, usually while overlooking what happened further in the past. They may also take recent events as an indicator of what is yet to come. For investors, this could mean taking on too much investment risk during a rising market or selling investments after a period of volatility.
This is the belief that what we own is more valuable than what we do not. Once an object or investment becomes our property, letting go of it can feel like a loss. Even if there is a better alternative available. This can cause investors to hold on to an investment even when it might be better to sell it.
The bandwagon effect involves following the crowd, rather than making your own judgments. In other words, you are ‘jumping on the bandwagon’. It can be especially common during times of uncertainty or when people are faced with a difficult decision. The bandwagon effect might lead investors to impulse-buy a rising investment after it’s received a lot of positive news coverage. Or perhaps to sell an investment after a friend or relative has sold theirs.
At AXA IM Select we have a robust, consistent investment process that helps us to avoid falling prey to behavioural biases.
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