Investing biases: How they affect our financial decisions

What drives us to make our financial and investment decisions? While our choices may seem logical and self-controlled, they can often be more complex than we realize.

Behavioural finance is a field of study focused on the psychological factors that influence investors’ decisions. Researchers discovered that often our errors in judgment can arise from mental shortcuts, emotional influences or social pressures.

Biases in financial decision making

There are two main types of behavioural biases that can affect investing.

• Cognitive bias arises from faults in our reasoning and how we process information.
• Emotional bias is driven by impulse or feelings and not backed by reason.

When navigating uncertainty, it’s important to stick to an investment strategy that’s based on your goals and time horizon. Staying true to your plan will help you avoid being influenced by biases, which can lead to selling an investment because of an emotional impulse.

Behavioural investing biases are comprised of five prominent concepts.

Mental accounting

People treat money differently depending on where it came from and what they think it should be used for. It’s common to guard some money and act cautiously when we’ve categorized it for a particular purpose. Often, people have multiple financial accounts labelled for various purposes, each with its own objectives and constraints. This can lead to potential conflicts and can impact your portfolio if your investments aren’t properly diversified and the overall asset allocation and risk exposures aren’t optimized. Goal-based investing emphasizes investing to attain specific life goals. Adapting your mental accounting bias can help ensure that your money is where it needs to be to reach your goals.

Loss aversion

Typically, there’s a greater emotional impact from a loss than a gain. This can cause people to hold a losing investment too long to avoid a loss. They might also sell a winner too soon to avoid the possibility of losing those gains. This combination can lead to an increase in portfolio risk by holding weaker assets and curbing upside potential by moving on from winners prematurely. Another result of loss aversion is excessive trading, with winners sold too frequently and reinvested into other assets.

Overconfidence

It’s easy to overestimate our level of knowledge and skill. For investors, it can lead to decisions that fall outside of our risk tolerance. Being overconfident can also trick our brain into believing it’s possible to consistently beat the market. It's important to leverage investment specialists and portfolio managers who make decisions backed by data, research and experience. Active management adapts to changing market conditions and tries to flow with the market by maximizing contributors and minimizing detractors.

Hindsight

Many of us find it easy to convince ourselves that we accurately predicted an event before it happened. This may lead to conclusions that we can accurately predict other events in the future and result in unnecessary and excessive risk-taking. We’re susceptible to the hindsight bias because it’s comforting to think that the world is predictable.

Herding

Herding behaviour occurs when investors follow what their peers are doing rather than making their own decisions. History has shown how herding behaviour can backfire on investors like with the Dot-Com and meme-stock bubbles. As the term suggests, bubbles result in rapidly inflated values. Investors pay a high price expecting to sell their assets to someone else at an even higher prices, without the financial data to support those valuations. This mindset often later results in a mass exodus of market participants when momentum slows down and valuations plummet.

Awareness is key

Biases can make it tempting for investors to try to time the market, especially when markets experience steep losses and the short-term outlook is uncertain.

But a rush decision to sell quality, well-managed investments can turn a temporary portfolio decline into a permanent loss – that’s because the market’s strongest days and weeks often occur when you least expect it.

This chart shows what happened to $10,000 invested in the S&P 500 between January 1, 2007 and April 23, 2025.

Missing the best days of the market

S&P 500Total Return (USD)

Source: Bloomberg/S&P Global

The initial investment of clients who stayed fully invested the entire time – including during the 2008 financial crisis, the market correction in 2020 and the 2025 tariff-related sell offs – grew to over $54,000, an annual return of nearly 12%.

Those who moved out of the market and missed the 10 best days made around $14,000, a 6% annual return on the initial investment. Missing the best 10 days cost the investor approximately $30,000.

Missing the best 20 days resulted in growth of only $4,000 or roughly a 2% annual return.

Missing the best 30 days caused a loss of principal and brought the initial investment of $10,000 down to just over $9,000, a negative 0.5% annual return.

It’s important to remember that time in the market is better than timing the market.

Awareness of your biases can help you stay focused on your long-term goals and avoid making decisions based on emotion.