Some biases are created while others are involved subliminally in our investment decision even though the notion is that we invest as rational people. In reality, even using rational theories like CAPM or efficient market hypothesis can prove wrong at times. Many studies have also proved how investors are not very composed during an investing decision. This applies anywhere in the world, though today, our focus is investment decisions in Canada.
This article will tell you about all the behavioral biases that taint your decisions related to investing in Canada. It would lead to results that you do not always have in mind. Keep reading to find out so you can prevent them in your next investment decision.
Behavioral Biases for Investing Decisions in Canada
There is no accurate reason as to why investors act a certain way. However, studies in the field of finance, sociology, psychology, economics, and finance have created a trail of clues for us to follow. Most of this work belongs to Daniel Kahneman, Amos Tversky, Richard Thaler, Robert Shiller, and more.
You cannot just decide to remove biases from your mind. They are predispositions in your life that have created a place deep inside your mind, This creates problems in investing.
Hence, we might not be able to expunge this problem eternally but knowing about where your flaws lie will make you conscious about them and probably avoid them during important decisions.
Investors have set up the anchor point for trading. For example, if you bought stocks of B company at the rate of $80/share. You will be tempted to not sell it below $80 despite signs from technical and fundamental practices showing that you might not be able to sell it above $50 now. You still ignore that advice and that leads to losses.
Your eyes are anchored to a certain price point, even though the previous price point is not viable now.
Overconfidence often affects the way we make decisions. It also stays amongst some investors and leads to overestimation while choosing a stock and making a profit.
This bias leads to overtrading and drowning in trading fees and having a non-diversified portfolio.
Loss aversion is also called aversion bias. We are more leaned towards the pain of losses. That means investors often tend to hold the stocks that have been going down in the hope of a rebound or sudden spike someday.
Here they might continue buying more stocks as it goes down. Loss aversion leads people to think about breaking even as they are enduring losses.
This follows after the Aversion loss. You sell your securities whose price has risen, to lock the current profit on that stock while doing nothing about the stocks that are going down.
Recency of Events
The current events also shape our perspective towards the world in one way or another and we might ignore the face but it’s inevitable. After the 2008/2009 crisis, the majority of investors collectively wanted to exit the market. When in reality, this was the best time to buy stocks at low prices.
That happens because the current events drive us to make decisions based on them which are also known as bounded rationality.
We regard the importance of events that are happening unconsciously. For instance, a stock performed well in the past, this will perform well in the future too, vice versa.
In the same way, fund managers with impeccable history and record ought to continue benefiting from a trend in the future too, although the good period ended a long time ago. Hence, we tend to have a notion that past performance also defines present performance.
An investor believes more in investing in local stocks, simply because they are something within their vicinity and they are aware of it. Hence, they move on to create portfolios that are brimming with local stocks and assets, leading to inadequate diversification or partial diversification.
Since we are not familiar with stock, that doesn’t mean it is risky. Even financial advisors lean on this belief. They guide their clients towards the familiar assets leading to a high sub-optimal and high-risk portfolio.
We hold an aversion to opinions that are opposite of what we think. An investor with information looks for more data that either backs their claim or supports it but does not disapprove of it.
Hence, when you like a stock, all positive information becomes factual and leads to an effect that is similar to the anchoring bias.
Mental accounting leads us to perceive the use of different money in different manners. Some examples are:
- People tend to spend money more via card than cash.
- A dollar earned has more value than a dollar found.
The sheep follow their herd! Hence, investors also put their faith in the wisdom of the crowd, like everyone is setting goals upon a single stock so I should also buy it, vice versa. This is one of the things that impact investment decisions in Canada or anywhere else in the world as well.
While numbers define a safe side, that can also mean you are just jumping off a void cliff with the others, because they are also as clueless as you.
This can be understood with the recent hype around cryptocurrencies. Also, you can find instances of this in the previous crashes, Tulipmania, bubbles, and burns.
After being victorious with your portfolio, you gladly take the credit. However, if something goes down the market and others’ opinions are on the noose. Investors are biased and cannot decide between the results from luck and skill.
Getting Rid of the Behavioral Biases
Our brain is the home to millions of neurons that drive us to take actions and make decisions, and drown in a pool of chemical impulses, hence you cannot avoid the biases altogether.
Hence, we bring some strategies for you to reduce the effect of these biases to some extent:
Indulge in Passive Investing
A diversified portfolio is a must. You should be aware that the biases will be looming around you, which will make investing in ETFs or stocks easier.
You should fix one stock and align it with the risk tolerance you have, and keep them going for the long-term.
Re-balanced Through a Schedule
You should rebalance your portfolio once or twice in 12 months. Over rebalancing can lead to piled-up trading fees and unnecessary behavior.
Rely on Automation
You should not always be monitoring the market leaving everything else. Automate your investment which will lead to dollar-cost averaging. And it will buy more stocks at a low price, and less stock at a high price.
You should have long-term investing goals, and stop checking your portfolio all the time.
Frequent trading leads to Anchoring, trend-chasing, market timing, and other biases. Hence, trading less will help you contain the biases.
Don’t Look at Financial Affairs
It is one of the crucial points for making investment decisions in Canada. Financial people in the biz are always telling why something is happening in the business, and while it does contain a vial of truth, you should not be wound up to their advice only.
Hence you should avoid the financial market while it is full of conjecture that drives your biases more dominant. It would help you make investment decisions in Canada.
Listen to a Different View
You should not invalidate differing opinions right away. You should always consider both the supporting and differing opinions and draw the conclusion because often you can find good facts and figures in them.
The Bottom Line on Making Investment Decisions in Canada
You also have the option to opt for an expert for making investment decisions in Canada. If you are worried about the fee of a professional, you can rely on a fee-only advisor for some friendly advice. You can also avoid biases with a Robo-advisor, your friendly automated financial advisor. They are professionally managed and implement strategies successfully for you. So, you don’t have anything to worry about.