I am not a psychologist, but I have learned a little about decision making in business. Here are some common biases or mistakes that people need to be aware of when they are making important decisions in personal finance, business, and investments:
1. Anchoring Bias – This happens when one puts more emphasis on a certain piece of information. It can be the result of previous opinions and emotions. For example, one can get too attached to an investment such as a stock and believe that it will return to a certain price. As a result, the investment could be held for too long and could lose even more value.
2. Loss Aversion Bias – This happens when one is too afraid to take a loss causing him/her to lose even more. This can be illustrated by the idea that people tend to be more risk tolerant in the realm of losses and more risk adverse in the realm of gains. What does that mean? Take, for example, a situation where an individual is in a casino. If he wins a lot of money, he is less likely to risk it all in a bit gamble. However, if he loses some money, he is more inclined to continue playing to try to win it back (and puts himself in the position to lose more money). In this case, he is more risk adverse when he wins and more risk tolerant when he loses.
3. Sunk Costs – In business and also in any other personal decisions, you cannot base your decisions on past costs/expenses because they are already “sunk costs” and should no longer factor into your decision. Sunk costs are costs that cannot be recovered once they have been incurred. For example, if I bought a movie ticket before my friends arrived, and they decided they did not want to watch the movie, I have a decision to make: go watch the movie alone (which is not very fun) or spend time with them (which could be more fun). The cost of the movie ticket is a sunk cost since no matter what I choose, the money was already paid. The only factor in my current decision should be which activity would be more fun for me.
4. Overconfidence Bias – Many analysts struggle with this bias as they believe they are correct in their analysis. In fact, everyone is usually too confident that they are correct. Being too confident in your opinion might hurt you if you refuse to listen to others or if you do not do the proper research to support your opinion.
5. Confirmation Bias – This occurs when one looks for information that confirms his own biases. For example, if I think company X is really good, when I research the company to see if I want to invest in it, I might only look for the information that confirms my bias. I might ignore information that tells me that the company could struggle in the next year.