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Investors today have their hands full, juggling patient care with life's myriad demands — and making savvy financial decisions is yet another thing on an endlessly overflowing plate.
However, mental traps or biases can sometimes lead even the brightest minds astray when it comes to finances. Investors can make smarter financial decisions when they recognize these pitfalls and engage in strategic ways to avoid them, setting the stage for smarter, more effective investment choices.
Overcome confirmation bias
Confirmation bias is like having blinders on: you only see what you want to see, and you only agree with opinions that match your own. This can be particularly risky for people managing their investments, as it makes them prone to overlooking vital warning signs, potentially sticking with bad investments or missing out on golden opportunities.
Sam Watkins, CFP® TrueNorth Wealth
TrueNorth Wealth is a zero commission, fee-only, financial planning firm. TrueNorth Wealth specializes in high-net-worth individuals. We offer academically sound financial planning, and we educate each client on what our investment philosophy is, and why. We take an active role in helping each client examine their tax bill each year and creating meaningful strategy to manage that tax liability. If you are looking for an exceptional advisor, call TrueNorth Wealth for a no-cost consultation, today! 801-274-1820Beating the confirmation bias requires a willingness to seek out and seriously consider information that challenges your beliefs — an exercise that's difficult for anyone. With that in mind, building a team of trusted financial advisors isn't just smart — it's essential. They'll provide diverse perspectives and unbiased advice that can safeguard your financial future.
Tackle loss aversion
The fear of losing money often looms larger than the thrill of making it, a phenomenon known as loss aversion, according to Investopedia. This can translate into panic moves, like hastily selling off investments at the first sign of a downturn and missing the chance to benefit from the market's eventual upswing.
The best defense against this bias is a good offense: a clearly defined investment strategy that you stick to, rain or shine. By committing to regular, scheduled investments, you take emotion out of the equation, ensuring your decisions are driven by strategy, not fear or anxiety.
Keep overconfidence in check
A little confidence goes a long way, but overestimating one's financial acumen can lead anyone down a risky path. This overconfidence can result in hasty, ill-advised investment choices and a false sense of security.
A 2023 CNBC article describes overconfidence bias as "overestimating one's financial acumen." In other words, you think you can do no wrong in terms of investing and financial decisions.
To avoid this trap, embrace lifelong learning — something intrinsic to many investors. The world of finance is vast and ever-changing, and there's always something new to learn. Also, diversification isn't just a buzzword — it's your safety net.
Spreading your investments across various sectors safeguards you from the risks of putting all your faith in one (potentially overestimated) opportunity.
Beware of recency bias
Recency bias is the mental quirk of giving recent events too much weight. According to Greg Iacurci for CNBC, recency bias can be harmful for investors, as recent events rarely affect investments in the long term.
Smart investing isn't about short-term wins—it's a marathon, not a sprint. Combat this bias by taking a comprehensive view of market trends, not just the latest hits and misses.
Allow historical data to guide your decisions, not the emotional high of a recent success. Making impulsive moves might provide an adrenaline rush, but steady, informed strategies pave the way for long-term financial security.
Don't follow the herd
It's human nature to follow the crowd, a tendency known as herd instinct. But when you follow the investment crowd, you might end up making choices that are ill-suited to your unique financial needs and goals.
Herd instinct "is a behavior wherein people join groups and follow the actions of others," Adam Hayes states for Investopedia. This kind of mentality often leads to jumping into investments at the wrong time, because the decision is driven by a fear of missing out rather than sound reasoning.
To combat this pitfall, develop a robust, personalized investment plan and stubbornly stick to it, even when the latest craze tempts you. And always, always do your homework. Independent research and due diligence are your compass in the ever-changing investment landscape.
By recognizing and understanding these biases, investors can sharpen their financial decision-making skills, paving the way for a future that's not just wealthy, but financially wise. This takes self-awareness, an unquenchable thirst for knowledge, a solid strategy and often, guidance from those who've been there — like the team at TrueNorth Wealth. After all, smart investing isn't about the money you make, it's about the money you keep, grow and use to achieve your long-term goals.
