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The human brain uses shortcuts and patterns to process information and make decisions quickly. This can be effective when learning a new language, picking up a new skill or making dinner plans. But it can lead to behavioural biases that can cause us to think and act in curious ways. Particularly when it comes to investing.

1 Source: Morningstar report: Who’s Influenced by behavioural biases? Everyone.

inside the mind of an investor graph 4

This article explores five common investor biases and how they can influence investment decisions.

How investor psychology can impact investment decisions

Biases can shape many of the investment decisions an investor makes. If left unchecked, these biases lead to deviations from plans - particularly when markets are moving dramatically.

An investor’s thoughts during Feb-June 2020 market swings

inside the mind of an investor graph 3

2 Source: Nasdaq, S&P 500 prices as of daily close February-July 2020.

Research shows that most people exhibit some bias in their investment decisions. Knowing about these biases and understanding their influence on investor behaviour is key towards curbing their impact on your portfolio.

Human brain with icons floating around - anchoring, loss aversion, recency, familiarity and confirmation
anchoring 23%, loss aversion 30%, recency 35%, familiarity 27% and confirmation 24%

We can explore these five common biases3 and how they affect investors.

  • Anchoring

    • What it is:
    Fixating on a specific reference point, like the price paid for an investment or market index level, and basing decisions around that one number.
    How it affects investors:
    Can cause investors to overvalue, or undervalue, asset prices or market performance based on an arbitrary number drawn from past experience.

    Tip: Follow a disciplined investment process no matter where markets are headed.

  • Loss aversion

    • What it is:
    Feeling losses much more intensely than feeling the reward from an equivalent gain.
    How it affects investors:
    By prioritizing the avoidance of short-term losses over long-term gains, investors may put the success of their long-term goals in jeopardy.

    Tip: Stay focused on long-term financial goals.

  • Recency

    • What it is:
    Placing too much emphasis on experiences that are freshest in one’s memory — even if they’re not the most relevant or reliable.
    How it affects investors:
    Believing that short-term trends will continue into the future may lead investors to ignore new information and be slow to react to changes in investment markets.

    Tip: Avoid common investor mistakes by tuning out short-term market noise and focusing on the bigger, long-term picture.

  • Familiarity

    • What it is:
    Preferring to invest in what is familiar. – especially from domestic markets. For instance, the average Canadian has 92% of their wealth in Canada.4
    How it affects investors:
    Leads to concentrated portfolios that hold only the most familiar investments – especially from domestic markets.This can increase portfolio risk and lead to a bumpier investment experience.

    Tip: Invest globally to increase diversification and reduce risk.

  • Confirmation

    • What it is:
    Seeking, or accepting, only information that supports what one already believes.
    How it affects investors:
    By ignoring information that doesn’t support one’s decisions, an investor can form unrealistic expectations that can lead to portfolio concentration and increased risk.

    Tip: Ask big picture questions and develop a more holistic view.

    3 Source: The Evolving Role of Behavioral Finance in 2020.
    4 Source: Investor Economics: Household Balance Sheet Report- Canada, 2021.

    Staying disciplined and focused on the key principles to successful investing can help you reach your financial goals.

    A diversified, actively managed portfolio can help you stay on track. Ask your advisor if a portfolio solution is right for you.

    Disclosure

    Please consult your advisor and read the prospectus or Fund Facts document before investing. There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. RBC Funds, BlueBay Funds and PH&N Funds are offered by RBC Global Asset Management Inc. and distributed through authorized dealers in Canada.



    This has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes, as of the date noted only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when provided.



    ® / TM Trademark(s) of Royal Bank of Canada. Used under licence.
    © RBC Global Asset Management Inc., 2023

    How to avoid biases when investing | RBC GAM

    Inside the mind of an investor