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And Practical Advice to Help You Avoid Them

By now, most everyone is familiar with the common mistake many investors make when they buy high and sell low. However, it’s not just panic selling that can wreck your portfolio. Your biases and beliefs, even those operating at a subconscious level, have the potential to significantly damage your investment returns and greatly impact your life’s savings.

  1. Recency bias – This is the tendency to assign importance to recent events. It’s common to believe that because a certain asset class has performed well recently, it will continue to perform well long into the future. Of course, that’s not necessarily true, and this bias may lead you to invest in an asset class at its peak. Additionally, believing an asset class is “due” to perform well because it has not performed well recently can be another form of this bias.
  2. Mental accounting – Mental accounting refers to a person’s tendency to view different sources of money differently. Of course, we all know that a dollar equals a dollar, regardless of its source. Yet, many people will treat a tax refund or lottery winnings differently than they treat a monthly paycheck. You may be more willing to take risks with unexpected windfalls than you would your own hard-earned income. There’s a chance these risks could lead to complete loss.
  3. Confirmation biasConfirmation bias explains our tendency to seek out information that strengthens and confirms our existing beliefs. Any evidence that disputes a strongly held belief is dismissed as incorrect or irrelevant. Confirmation bias can cloud you