Outsmarting Your Brain: Battling Cognitive Biases in Investing
In the world of finance, where rational decisions should reign supreme, our human brains often throw a wrench in the works.
6.23.2025
Cognitive biases – mental shortcuts influenced by emotions or personal experiences – can lead to significant errors in judgment, impacting our financial choices and potentially sabotaging our long-term investment goals. Understanding and actively combating these inherent biases is crucial for every investor.
Here are some of the most common biases discussed by Jesse Cramer and Gabe Chodak on The Trusted Partner Podcast:
- Loss Aversion: This powerful bias makes the pain of losing money feel twice as bad as the pleasure of gaining it. It often leads investors to sell “winners” too soon and hold onto “losers” for too long, hoping for a rebound. This irrational behavior, rooted in our evolutionary drive to avoid harm, can be detrimental to portfolio performance.
- Overconfidence Bias: Many investors believe they possess superior skills in picking stocks or timing the market. This inflated self-belief often results in excessive trading, poor diversification, and ultimately, underperformance. The reality is that consistently beating efficient markets like the S&P 500 is extremely difficult, even for seasoned professionals.
- Recency Bias: We tend to give undue weight to recent events, assuming current trends will continue indefinitely. During periods of market turmoil, recency bias can lead to panic and a belief that chaos will forever reign. A long-term perspective, acknowledging that volatility is a normal part of investing, helps temper this bias.
- Confirmation Bias: This bias drives us to seek out and trust information that confirms our existing beliefs while ignoring contradictory data. In investing, this can lead to echo chambers, reinforcing irrational fears or overoptimistic views, and preventing a balanced assessment of market conditions.
- Survivorship Bias: We often focus on the “winners” or “survivors” in the market (e.g., stories of early Bitcoin millionaires) and draw conclusions from them, while overlooking the many failures and losses along the way. This skewed perspective can lead to unrealistic expectations and risky decisions.
- Anchoring Bias: The first number or piece of information we encounter often acts as an “anchor,” disproportionately influencing subsequent judgments. In investing, this might mean fixating on a past purchase price rather than evaluating an investment’s current value or future potential.
- Herd Mentality: Humans are wired to follow the crowd, even when the crowd is wrong. This can manifest as FOMO (Fear Of Missing Out), leading investors to pile into popular assets during speculative bubbles. When the herd turns, the losses can be swift and severe.
Combating Your Biases: Practical Strategies
While these biases are deeply ingrained, we can take steps to outsmart our own brains:
- Acknowledge and Accept: The first step is recognizing that these biases exist and that you are susceptible to them.
- Seek Diverse Perspectives: Actively consume information from various sources, even those that challenge your current views.
- Embrace a Long-Term Plan: Develop a well-thought-out financial plan and investment strategy when emotions are calm. Stick to this plan, avoiding impulsive decisions driven by short-term market swings.
- Automate Decisions: Set up automated deposits or withdrawals to remove emotional interference from regular investment activity.
- Enlist a Trusted Advisor: A good financial advisor can act as a rational third party, providing objective counsel and helping you stay disciplined during emotional times. They can serve as your “disciplined hand on the wheel.”
- Focus on What You Can Control: Rather than obsessing over daily market fluctuations, focus on your savings rate, diversification, and long-term asset allocation.
By understanding these cognitive biases and implementing practical strategies to mitigate their influence, investors can make more rational decisions, stay on track with their financial goals, and ultimately achieve better long-term outcomes.
For a deeper dive into cognitive biases, listen to the full episode of The Trusted Partner Podcast.
Disclosure: Unless stated otherwise, views, opinions or forecasts expressed in this blog are those of the author and do not necessarily reflect those of the Adviser and/or its employees. The contents of this blog are distributed for informational purposes, and are not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Nothing in these communications is intended to be or should be construed as individualized investment advice. All content is of a general nature and solely for educational, informational, and illustrative purposes.