Financial Adviser's 4 tips to improve your financial decision making

We’d like to think that we’re driven solely by logic and evidence when it comes to financial matters, but this isn’t always the case.

We’re all prone to influences and bias in our everyday lives, not least when investing. In my role as a Financial Adviser, I help clients on a daily basis with their finances and investments and get to see some of these first-hand.

Behavioural finance, psychology of investing, works on the assumption that people aren’t always rational investors. It argues that we’re often guided by emotional judgements that can run counter to what logic dictates.

Below I highlight 4 common patterns of thinking that might affect your investment decisions, and how you can try to overcome them.

This article is not personal advice. If you’re unsure, please seek advice. All investments fall as well as rise in value, so you could get back less than you invest.

1. Loss aversion

A purely rational person should be just as happy with a profit of £100 as they would be unhappy with a loss of £100. But research suggests that the pain of a loss is felt more strongly than the pleasure of a gain.

This can result in a tendency to not want to sell an investment at a loss. Clearly, this is driven by emotion and not entirely by rational decision making.

This is linked to ‘the sunk cost fallacy’. The action of sticking with a loss because you’re already invested. Think of it a bit like buying a cinema ticket for a really bad film but rather than leaving the cinema, you stick it out because you’ve paid for the ticket.

Tip: One way to overcome the ‘fear’ of selling at a loss (when it’s appropriate, of course) is to ask yourself, if you didn’t already hold that investment, would you buy it today?

2. Hindsight bias

In the aftermath of an event, it’s easy to find experts who can provide detailed explanations as to why an event happened. This can cause us to believe an event was easy to spot and therefore avoidable. In reality this is rarely the case.

Tip: Try not to focus too much on macroeconomic events you can’t control and short-term thinking. It’s far more important to take a step back and think about what’s happening in your world. Think about the long term, and give your investments plenty of time to ride out shorter-term market fluctuations.

3. Herding

This concept refers to the tendency for people to ‘follow the crowd’.

The Bitcoin craze is a great example. But perhaps the most famous example of this phenomenon was during the dot-com bubble that occurred around the start of the millennium.

Tip: When investing, it’s important to build a well-balanced and diversified portfolio. Make sure you’re not putting all your eggs in one basket.

4. Confirmation bias

These days, there’s so much information out there, it can be hard to know what to pay attention to.

Sometimes we’ll actively look for information that simply confirms what we already believe. For example, you might have an idea in mind for your next financial move. When you research it, you ignore the nine articles which say it might not be such a good idea, and listen to the one which says you should go for it.

Tip: Most financial decisions are too big to be made on gut feeling. Get some balanced views and don’t ignore the experts.