Investor's Psychology

Understanding the 7 Common Mind Traps While Investing

Created on 10 Nov 2023

Wraps up in 4 Min

Read by 3.2k people

Updated on 31 Jan 2024

Understanding the 7 Common Mind Traps While Investing - Finology Insider

You know how sometimes you're dead sure about something, but it turns out you're way off? Well, it's those sneaky biases playing tricks on how we think and make decisions. In this article, we'll take a ride through seven common types of biases that mess with our heads without us even realising.

To make the reading more fun, I'll throw in a question while discussing each bias for you to ponder on. It’s a chance for you to think if you’ve been in a similar spot or not. And hey, remember that…

Be honest with yourself because recognising these biases can be eye-opening. Alright, so first up is…

Overconfidence Bias: The 'I Got This' Trap

Have you ever felt a rush of certainty when making an investment, thinking, "I’ve got the Midas touch"? I am sure there have been times when you were absolutely certain about something, but it turned out you were wrong. 

It's like feeling you're the boss at something, only to find out you're not. It's that moment when we're a bit too confident about our abilities or knowledge. It can lead us to make decisions without considering all the angles. 

That happened to me once. I was super excited about an investment, convinced it was going to be a big win. But guess what? I didn't even think about the possible downsides. 

"I’ve got this figured out," I thought to myself, feeling like I was invincible. But, surprise, surprise, this is what happened to my stock and the investment I made. 👇 

That's when I realised I fell into the trap of Overconfidence Bias, thinking I was way smarter than I actually was in the world of investments. It can mess with your financial choices big time. Check out Overconfidence Bias: Are you as smart as you think? to learn more about how it can affect your decisions. 

Hindsight Bias: The 'I Knew It All Along' Syndrome

That sense when something happens, and suddenly, you feel like you totally called it beforehand? It's like looking back at something and thinking, “Oh yeah, I saw that coming.” It messes with our memory and makes us believe we knew things before they happened, even when we didn't.

When the investment I talked about earlier didn't pan out as expected, I felt that I knew this would happen! That's Hindsight Bias creeping in, reshaping my memory to make it seem like I predicted the failure all along. 

Curious to dive into this 'I-knew-it-all-along' phenomenon? Click here: What is Hindsight Bias? - An Overview to understand how Hindsight Bias influences financial reflections.

Representativeness Bias: Judging a Book by Its Cover

I am sure you must have made assumptions about something or someone based on looks or superficial similarities. You know, like seeing a few common things and thinking everything else is just the same. This bias can lead us to make decisions based on stereotypes rather than real facts. That's the Representativeness Bias. 

It often happens that when eyeing a potential investment, I find myself leaning towards opportunities that look similar to past successes. 

Curious to learn how this bias influences our thinking? Check Representativeness Bias: When Your Past Affects Your Future to explore the impact of this bias and to know how to prevent it.

Self-Attribution Bias: Credit Where It's Due (Or Not)

Let's talk about success and failure! When my investment soared, I patted my own back. But when it took a nosedive, I blamed the economy. That's the Self-Attribution Bias in action. More like being the hero of your success stories but shifting the blame to outside factors when things don't go well. 

For more details, check Self-Attribution Bias: Your Gateway to Narcissism.

Confirmation Bias: The Echo Chamber of Thoughts

Have you ever only looked for things that agree with what you already think? Or imagine seeking advice that aligns perfectly with your investment ideas, ignoring all the contrasting opinions. Guilty as charged! 

That’s the tricky Confirmation Bias at play. This bias keeps us away from considering different viewpoints. 

Once, while seeking information about my investment from an experienced individual, I happened to only pay attention to sources that confirmed my beliefs, conveniently ignoring the conflicting advice. This Confirmation Bias limited my viewpoint back then. 

Curious to understand how this bias affects financial decision-making? Click here for a closer look at Confirmation Bias.

Anchoring Bias: The First Impression Fixation

Ever found yourself getting stuck on the first piece of information you get? More like being glued to a certain number or idea and letting it guide all your thoughts and decisions. 

This has happened to me. I am, many a time, fixated on the initial, optimistic prediction of the investment's success. As a result of which I become too confident, neglect diversification, and this leads to emotional decisions and financial setbacks. Click here to explore how Anchoring Bias shapes our Investment decisions.

Mental Accounting Bias: Splitting the Budget

In managing my finances, I mentally split my budget into various compartments, spending extravagantly in some areas while being overly cautious in others. This Mental Accounting Bias leads to irrational spending habits. This bias can make us spend money in weird ways because we mentally split it up.
For more details, check: What is Mental Accounting Bias?

The Bottom Line

So there you have it - my little examples to help you understand these sneaky financial biases. You know, I would attribute these biases to fog on our glasses, which distorts our view of the world.

By understanding these sneaky biases, we can catch ourselves when we're about to fall into their traps. I’m slowly steering towards more conscious and balanced financial decisions. Why not join me? 

Here's to setting sail on a more informed and bias-free financial adventure!

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Sakshi Dhakre

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Sakshi is an adventurous spirit who enjoys both the intellectual stimulation of Finance and the sensory experiences of good food and nature’s beauty. She has a passion for delving into complex financial topics and distilling them down into easy-to-understand insights. When she's not poring over financial reports, you might find her exploring a new corner of the city, trying out new restaurants and cuisines or admiring the beauty of the night sky.

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