Thinking through biases

What are biases and how do they happen?


You might believe that you think and act logically all the time, but in fact all humans have hidden biases they’re not aware of.

There are two types of biases – cognitive and emotional. Cognitive bias happens when you make a decision based on short-cuts or rule-of-thumbs, also called mental heuristics, to make decisions easier or faster.

On the other hand, emotional bias happens when your feelings overrule your thinking when you make a decision.

Ultimately, humans are irrational and that makes things complicated – especially investing.


Why is recognizing biases important?


It’s important to understand your biases as they can impact your investments and even the wider markets. Market bubbles are sometimes formed because of human biases in investing.

The first step to reducing biases is to be aware of them. If you know how your biases work, it can help you avoid making decisions that you might regret later.

It can also help improve your long-term investment returns.

For example, it could help you avoid the situation of buying high and selling low, of trading too often, or having too high a proportion of home country stocks in your portfolio.

You can’t completely cut biases from your decision making, but you can reduce how much impact they have. One way would be to have defined limits for when to cut your losses.

You can also make the effort to seek out opposing arguments to your decisions and set up a more structured investment process.


What kind of biases impact investing?


Here are some common biases you might be susceptible to:

  1. Loss aversion: This is the tendency to avoid losses over making gains because the pain of the loss is worse than the pleasure of the gain. It can lead investors to avoid any risks and hold on to falling stocks for too long.   
  2. Sunk cost fallacy: When the time and money already spent is used to justify further investment. This can result in the opposite phenomenon of holding on to losing stocks for far too long. 
  3. Anchoring: This describes an overreliance on one piece of information when making a decision. 
  4. Confirmation bias: The tendency for investors to seek and interpret information that confirms their views means they are less likely to change their mind, even if their investment thesis is wrong. 
  5. Emotional connection: Being emotionally involved with an investment – typically in family businesses or inheritance – can result in a lack of portfolio diversification.
  6. Price targeting: Investors determine an arbitrary price level that the stock has to breach before they sell. 
  7. Familiarity bias: The preference for a familiar investment leads investors to concentrate stocks in certain sectors or countries over other viable options. 


How can you prevent or limit bias?


Many of these biases can be reduced if you take emotions out of your decision making process, and rely less on simple short-cuts. One way of doing so is to carefully document your investment thesis and come back to evaluate it regularly. It’s important to look at different angles and seek out opposing arguments. Doing in-depth work to determine a stock’s fair-value is also effective in helping you assess when best to buy or sell your positions. As with any decision-making, it’s best to take time to think and do your homework.



Cognitive biases in decision making happens when you rely on mental short-cuts, while emotional bias occurs when your feelings overrule thoughts.

Being aware of your biases and taking steps to reduce them can help you avoid making the wrong decisions and improve your long-run investment returns.

You can reduce your bias impact by setting defined investing limits, looking at different angles to your point of view, and setting up a more structured investment process.