How to avoid cognitive errors in investment decision-making

In the decision-making process, cognitive biases are more common than we think and can have a negative impact on the profitability of our investments. These biases affect our perception and judgment, leading us to make decisions that are not entirely objective. Some of the most frequent mistakes include:

• Overconfidence effect

Excess confidence in our own decisions is a very common mistake. After achieving a positive outcome, such as a profit from a successful investment, it’s easy to fall into the temptation of taking on greater risks, convinced that we’ll always make the best decisions. This overconfidence can lead us to invest in riskier assets without proper evaluation, potentially resulting in significant losses.

• Confirmation bias

This bias arises when we seek information that supports our existing beliefs, ignoring any data that contradicts them. Instead of making decisions based on impartial analysis, we tend to look only for what confirms what we already think. This can cause us to miss valuable opportunities or remain invested in assets that are no longer profitable.

• Herd mentality

In many cases, investors tend to follow the majority without conducting thorough analysis. This tendency can lead us to buy assets at peak prices, when the markets are overvalued. The behavior of following the crowd without considering market fundamentals significantly increases the risk of losses when prices eventually fall.

• Loss aversion

This psychological bias leads us to avoid losses at all costs, even if that means sacrificing the potential gains. Conservative investors, for example, may feel uncomfortable with the idea of taking risks, which could lead them to make decisions that result in an opportunity cost, preventing them from achieving their financial goals.

• Anchoring effect

This bias refers to the tendency to base investment decisions on the past value of an asset, such as its historical price. Some investors make decisions based on positive data without considering all the available information, which can lead to faulty conclusions as to the true value of an investment.

These and other cognitive biases can directly impact the profitability of our investments. By falling into these errors, we may buy assets during periods of overvaluation, fail to diversify our portfolios adequately, or follow trends without conducting a rigorous analysis. Ultimately, this leads us to assume unnecessary risks and increase the likelihood of losses.

To counteract these biases and make more objective decisions, it is important to consider some key strategies:

• Training and professional advice

While more investors now have access to technical training on financial markets, financial education alone is not enough. Complementing this training with the support of a private banker or financial advisor is essential. These professionals can provide an outside perspective and help investors consider alternative viewpoints, preventing decisions from being overly influenced by personal beliefs or biases.

• Third-party review of strategies

As in the previous point, having experts review and analyze our strategies is an effective way to avoid personal biases. An experienced advisor can offer a more objective approach and help identify areas for improvement, adjusting decisions to maximize returns and mitigate unnecessary risks.

• Risk Management

One of the keys to successful investment is proper risk management. Today, financial regulations and investor protection measures are more advanced than ever. Being guided by an experienced bank and having a solid risk management plan can significantly reduce the likelihood of making costly mistakes.

• Use of backtesting tools and simulators

Backtesting and simulators tools allow investors to test different scenarios and project future returns based on historical data. These tools, when provided by a third party with technical experience, can offer a clearer and more objective view of investment decisions, helping to avoid errors caused by emotional or subjective biases.

• Continuous portfolio monitoring

It is essential to regularly track and review investment portfolios. With this in mind, the role of a banker or financial advisor who actively oversees the progress of investments is crucial. This will allow us to adjust our strategy as market conditions change, thereby improving risk-adjusted returns and reducing errors in the investment process.

In conclusion, it is important to be mindful of cognitive biases that can influence our decisions, and take measures to minimize them. By working with expert professionals, leveraging technological tools, and regularly reviewing our strategies, we can improve our investment decisions and increase our chances of achieving the financial goals we have set for this year.