4 Behavioural Biases That Can Negatively Impact Your Wealth Creation Journey

There are several psychological factors that influence your investing decisions. It's important to have the right attitude and behaviour to make the right investment choices. For instance, both domestic & global markets took a significant hit following the COVID-19 pandemic in March 2020. After seeing the markets fall to an all-time low and a drop in the value of investments, many investors became fearful and started liquidating their investments in an effort to cut down their losses. However, later in 2020, the markets recovered just as swiftly, which solidified their losses. Thus, multiple factors, including behavioural biases, can influence your financial decision.

Many investors are susceptible to making bad investment choices based on incorrect conclusions or emotional reactions to particular financial information. To become a successful investor, you must exercise caution when making investment decisions and stay away from cognitive biases.

According to financial experts, building wealth has a lot to do with your behaviour. Morgan Housel, in his book, 'The Psychology of Money' says, "A genius who loses control of his emotions can be a financial disaster. The opposite is also true. Ordinary folks with no financial education can be wealthy if they have a handful of behavioural skills that have nothing to do with formal measures of intelligence."

Behavioural finance, a part of behavioural economics, focuses on the psychological factors that influence your investment decision and consequently affect your wealth. It suggests that people often make decisions based on emotional or cognitive biases.

However, by being aware of these behavioural biases and simply following a few key steps, you can reduce the impact of these biases on your wealth creation journey.

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But what are these biases, and how to ensure you don't commit these and imperil your hard-earned wealth?

In this article, we explain 4 key behavioural biases in detail and assist you with simple yet effective ways to overcome them.

1. Present Bias

The concept of present bias is crucial to the theory of self-control in behavioural finance. It is associated with an individual who is likely to spend now and less inclined to save for the future. In a broader sense, the term "present bias" is frequently used to refer to the desire for instant gratification while making decisions. The tendency to favour current pleasure over potential future benefits or returns is known as present bias.

For example, an investor may prefer an instrument that gives good returns in the near future (2-3 years) rather than investing in retirement funds because retirement seems so far away in the future. Present bias is when people focus more on short-term goals than long-term goals. A present-biased person might prefer to spend their money today to satisfy their instant gratification rather than saving for the future and practice delayed gratification.

Wealth creation is a long-term financial goal spanning over decades. Thus, you should avoid falling prey to Present bias, as it prevents you from investing with a long-term approach towards your wealth creation journey.

2. Status-quo Bias

Status quo bias, often known as inertia or laziness, is one bias that most individuals possess. For instance, some millennials keep putting off starting their retirement plans because they believe it's too early to plan for retirement.  Since they still have at least 25 to 30 years until retirement.  This tendency for status quo or inertia is pretty typical. Despite being aware of the benefits of compounding, you may keep putting off making wise investing decisions because they demand too much effort.

By delaying investments, you lose out on several years of wealth building. Time plays a vital role in helping your money grow. Starting today will provide you with a longer time frame to reach your financial objectives, which will allow you to take advantage of the power of compounding.

Procrastination compromises the compounding effect of investments. Investing for a short period results in lower returns, which significantly affects your goals of wealth creation. However, this bias doesn't impact only those who are yet to start investing, even those who actively invest might find themselves reluctant to switch over to other worthy investment options. However, staying put with a consistently underperforming investment can have a detrimental effect on the returns on your portfolio and your efforts to build wealth. Do note It is crucial to periodically review your investment portfolio.

3. Loss Aversion Bias

Investors often feel the pain of loss more than the joy of gains. Loss aversion bias is the tendency to avoid losses over maximizing gains. For instance, an investor invests equally in two stocks 'A' and 'B'. The investor is likely to feel the pain of the correction of stock 'B' more than the appreciation of stock 'A'.

Even though equity markets are proven to offer superior returns over the long run, investors prefer low-risk assets due to this loss aversion bias. Loss aversion causes you to avoid taking even small risks that can help diversify your portfolio for wealth creation and potential returns in the long run.

Sometimes, you need to correct the asset allocation due to changes in dynamic market conditions. While patience is critical to creating wealth in the long term, you need to be intelligent enough to identify the wrong investments and switch to worthy ones. However, your loss-aversion bias inhibits you from exiting your consistently underperforming assets since you are fearful of suffering further losses. To overcome this bias, you may not leave it up to the emotion or fear of losses over seeking gains. Construct a robust investment plan as per your suitability and adopt some risk within your tolerance by considering assets that perform well.

4. Herd Mentality Bias

We are all vulnerable to being influenced by what our elders say and, more often than not, what our peers do. As a matter of fact, this is exactly how trends or fads start. Herd mentality is the phrase used to describe when an investor makes investments in accordance with other investors' and/or the majority's decisions rather than basing those decisions on current, accurate financial data.

The fear of losing out frequently motivates this behavioural bias. After all, you want to avoid the feeling of being left out when everyone around you is making money, and you chase returns by following the herd. This is often driven by peer pressure and the quest to earn more. One investor makes a quick buck from the stock market, and others join the bandwagon. Thus, the "bandwagon effect" is another name for the herd mentality bias. In this process, the herd mentality that frequently engulfs even seasoned investors causes many investors to take on more risk than they can bear.

Comprehensive research and a need-based approach are essential to pick the best and most suitable investment avenues. If you are following a sensible approach with thorough due diligence while investing, it will assist you in gaining optimal returns in the long run. But if you follow the herd, then you may not be on the right path to wealth creation. Even when you rely on external research reports for making valuable investments, carefully ascertain whether their views expressed are independent and unbiased.

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To Conclude...

Your investment decisions are influenced by various factors, including these behavioural biases, which can cause financial errors. If you are aware of these biases and can figure out how to get beyond them, you may be able to make sound investment decisions and build a robust investment portfolio.

The primary reason many investors struggle through these behavioural biases that influence their investment decisions is their lack of financial literacy. Financial knowledge helps you become financially aware and make informed investment decisions. After all, you will have a better understanding of these biases if you are financially literate. For successful investment decision-making, you must understand your behavioural biases and mitigate the risk on your investment portfolio and wealth creation journey.

Therefore, break away from these behavioural biases before it's too late. The sooner you make wise financial decisions, the closer you move to financial freedom and become a successful investor.

It is time to empower yourself with the weapon of financial knowledge and overcome these behavioural biases and stay focused on the path of long-term wealth creation.

Happy Investing!

Warm Regards,
Mitali Dhoke
Jr. Research Analyst