Common Cognitive Biases and How They Impact Your Investments

We all like to believe we make smart, logical decisions when it comes to our money. But the truth is, our brains sometimes trick us into making choices that aren’t always the best. These mental shortcuts, called cognitive biases, can cause us to make mistakes, especially when we’re investing.

In this post, we’ll break down four common cognitive biases that can affect your investment decisions: confirmation bias, herd mentality, recency bias, and loss aversion. Understanding these can help you make smarter decisions with your money.

Imagine you’re really excited about electric cars. You believe they’re the future, so you start looking for news that says electric cars will dominate the market in the next few years. You find articles and expert opinions that support this idea, and you feel great about your decision to invest in electric car companies. But when you come across news that points to challenges for the electric car industry—like battery shortages or new competition—you ignore it, thinking, "That’s just a temporary issue."

This is confirmation bias. It’s when we only pay attention to information that agrees with what we already believe and ignore anything that disagrees. This can blind us to important risks or different viewpoints. To avoid this, try to look at all sides of the story before making an investment. It’s important to consider the risks as much as the potential gains.

Think about the last time a new trend got everyone talking. Maybe it was a new diet, a viral video, or even a hot stock or sector. In investing, this happens a lot—when everyone is talking about how great a certain sector is, like technology or renewable energy, it can feel like you should jump in too, just to not miss out.

This is herd mentality—when we follow the crowd just because everyone else is doing it. But by the time you jump in, the best opportunities might have already passed, and you could be buying at a high price. A recent example? After COVID-19, everyone rushed into tech stocks because they were booming. But not everyone made a profit—some bought in too late, and the market corrected.

The lesson here? Don’t just follow the crowd. Do your own research and make sure your investments fit your long-term plan, not just the latest craze.

Have you ever eaten at a new restaurant, had a fantastic meal, and then told everyone it’s the best restaurant in town? That’s because the experience was fresh in your mind. In investing, something similar happens. When the market has been going up for a while, people start to believe it will keep going up forever. After the COVID-19 crash in 2020, the market rebounded really fast. Some investors thought this rapid growth would continue indefinitely, so they invested even more. But, markets don’t move in straight lines—they go up and down.

This is recency bias—we give too much importance to what’s been happening recently and forget that markets have a longer history of ups and downs. If you make decisions based on the last few months instead of looking at the bigger picture, you might set yourself up for disappointment when things change. To avoid this, always remember: markets are cyclical, and what goes up must come down (and vice versa).

Say you buy a new smartphone, and after a few days, it gets scratched. The pain you feel from that small loss can be stronger than the happiness you felt when you first bought the phone. In investing, this is called loss aversion—the fear of losing money feels much worse than the joy of making it.

For example, if the market drops and your portfolio loses value, your instinct might be to sell everything to avoid further losses. But by doing this, you could miss out on the market recovery, which typically follows. Instead of reacting to short-term losses, remind yourself that investing is a long game. If you stay invested through the ups and downs, you’re more likely to see positive returns over time.

Cognitive biases are like hidden traps that can influence your investment decisions without you even noticing. Whether it's following the crowd, focusing too much on recent trends, or being afraid of losing money, these biases can stop you from making smart choices.

The good news? Once you know these biases exist, you can catch yourself before they lead you astray. By being aware of confirmation bias, herd mentality, recency bias, and loss aversion, you can take control of your investment decisions. Focus on the big picture, think long term, and remember—successful investing isn’t just about picking the right stocks or sectors, it’s also about managing your own behavior.

The market will always have its ups and downs, but if you stay calm and stick to your plan, you’ll be much better off in the long run.