Know the five behavioural biases that are damaging your investments

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Herd mentality: In behavioural finance, herd mentality bias refers to the tendency to follow and copy what others are doing. The tendency to join the crowd is a common trait, also known as the ‘bandwagon effect’. Example: most funds are focused on beating the index on a consistent basis.

So, most of them are either overweight or underweight on a particular sector quite uniformly. This leads to under diversification in the investor’s portfolio despite investing in different funds. Recency bias: Most investors tend to give more importance to short-term information, instead of weighing investments over longer time periods, across market cycles (bull and bear) and understanding the array of underlying undercurrents in play.

This is known as recency bias. For example, if a sector generated exuberant returns in the recent past, investors typically find it difficult to make a significant cut in position size despite extremely expensive valuations and vice versa. Confirmation bias: This bias comes from the field of cognitive psychology, where one shows the tendency to search for or interpret information and retain it in a manner that matches their preconceived notions or belief systems.

This is one of the biggest biases, as most of us are prone to it. For example, if investors believes that the market outlook is positive or bullish, they may look at the data that vindicates this belief and ignores the risks or the headwinds in play. It gives a sense of overconfidence, while fair evaluation is thwarted.