Cognitive Biases to Know when Investing or Starting a Business

Confirmation Bias

Confirmation bias is finding information that only supports your preconceived idea. It is important not to answer a question before you even start researching. Otherwise, you will only see information that supports your viewpoint. It is essential to be open-minded and explore all sides of an argument.

Endowment Effect

In a past research study, when a group of people were given a mug, when asked how much they would be willing to sell it for, the average value was estimated at $7.12. When the second group were asked how much they would buy the mug for, it was priced significantly lower, around $2.87. The study illustrates people's perception that what they own is more valuable. This can be caused by "loss aversion" and how we hate feeling like we are losing money when we sell.

Loss Aversion

Loss aversion suggests that people are more motivated to avoid losses than potentially obtain a benefit. This principle explains why some people will still hold an asset that is not performing in the hopes of making their money back. It is crucial to weigh up the opportunity cost of retaining the investment to inform future decisions.

Dunning-Kruger Effect

Is where you think you are smarter than you are. For example, you overestimate your ability to pick stocks.

Choice Overload

It can be difficult to make a decision when there are lots of options.

Availability Heuristic

Also known as availability bias. It's when you make a decision based on the information you recently heard. For example, buying a stock just because you saw it in the news recently and recall a friend talk about it so you assume it must be good.

Herding

Is doing something because everyone else is. If everyone is doing it, then it can inflate the price and be overvalued.