Emotions, mental shortcuts, and flawed reasoning often interfere with sound judgment of even the most seasoned investors. This is the essence of behavioral finance, a field that explores how psychological biases shape financial decision-making.

These biases fall into two main categories: informational and emotional. Understanding both—and seeing them play out in real-life scenarios—can help investors make more rational, long-term decisions.

Although the names are fictitious, the events are very real and very common – I have fallen victim to a number of these biases in my investing lifetime, and have seen family members, friends and colleagues do the same.

Informational Biases: Misjudging the Message

Informational biases occur when we interpret, weigh, or recall data incorrectly. These mental shortcuts lead us to draw false conclusions or make overconfident bets based on flawed perceptions.

1. Confirmation Bias

This is the tendency to favor information that supports our existing beliefs, while ignoring or dismissing conflicting evidence.

Example: Alex, a business school graduate, became convinced an up-and-coming fintech company was a guaranteed long-term winner. Once invested, he started filtering the information he consumed—seeking out bullish articles, avoiding skeptical analysis, and dismissing any red flags. When the stock declined on poor earnings, growth disappointments and regulatory issues, he didn’t reevaluate. He simply doubled down, again and again, riding the stock down and down. His portfolio and entire financial wellbeing paid the price.

2. Recency Bias

Recency bias causes us to overweight recent events when predicting the future, as if what just happened will keep happening.

Example: In late 2020, many investors flocked to a high-profile innovation-focused fund that had posted eye-popping returns—over 100% in a single year. The fund, loaded with disruptive tech names, was on magazine covers and hailed as the future of investing.

Encouraged by the recent performance, investors poured in billions, assuming the trend would continue. But much of the surge was driven by a unique, stimulus-fueled environment. As interest rates began to rise and market dynamics shifted, the fund’s holdings stumbled—hard. Over the next year, the fund gave back much of its gains, leaving many latecomers severely underwater.

This is a classic case of recency bias—chasing investments with recent past outperformance without considering the underlying risks or whether the market conditions that drove that success were sustainable. This is one of the core reasons that individual retail investors significantly underperform even the funds they are invested in – chasing performance, and picking the fund primarily because it has outperformed in the past.

3. Anchoring Bias

Anchoring is when we fixate on an arbitrary reference point—usually a price—and base decisions around it, even when that number no longer makes sense.

Example: Mark bought shares of a biotech ETF at $72. When the price dropped to $58 due to a failed clinical trial and deteriorating fundamentals, he told himself, “I’ll sell once it gets back to $72.” But that number had no relevance anymore. It was just a mental anchor. As the stock continued to fall, his inaction cost him even more.

4. Hindsight Bias

Hindsight bias leads us to believe that past events were more predictable than they actually were. We rewrite our memories, thinking we “knew it all along.”

Example: After a major tech stock crashed in 2022, several investors in online forums claimed they had “seen it coming.” But most had held the stock until the fall, reacting just like everyone else. Their hindsight narrative made them feel smarter than they were—encouraging the same risky behavior in the future.

5. Availability Bias

This is the tendency to rely on easily recalled or sensational information, rather than what’s relevant or statistically sound.

Example: During the meme stock frenzy, Dave heard about a company skyrocketing on social media. Even though he had never researched the stock, he jumped in based on viral tweets and trending headlines. He ignored the company’s financials and business model—because what was loud and recent felt more important than what was accurate.

Emotional Biases: When Feelings Drive Decisions

Emotional biases come from personal beliefs, experiences, and fears. They’re often more deeply rooted and harder to detect because they feel intuitive—even when they’re irrational.

1. Loss Aversion

People feel the pain of losses more than the pleasure of equivalent gains—about twice as much, in fact.

Example: After the 2008 financial crisis, Michael, a mid-career professional, shifted nearly all of his retirement savings into conservative bond funds and money market accounts. The market crash had rattled him, and he didn’t want to feel that kind of loss again. Even as the economy recovered and the stock market entered a decade-long bull run, Michael stuck to his defensive allocation. He told himself he was “just being cautious,” but in reality, he was driven by loss aversion—the psychological tendency to fear losses more than we value potential gains. Over time, his portfolio grew—but at a much slower pace than it could have, and as he neared retirement, his nest egg was far smaller than it could have been. Loss aversion doesn’t always look like panic selling—it can also show up as an overly conservative strategy that sacrifices long-term returns in exchange for short-term comfort.

2. Overconfidence Bias

Overconfidence leads us to overestimate our abilities, knowledge, or control over outcomes. It often results in risky decisions and poor diversification.

Example: Jason made a few lucky stock picks in 2020 – though he attributed those wins to his superior stock picking skills. Flush with success, he abandoned his diversified ETF strategy and began actively trading with concentrated bets based on personal hunches. He believed he had a special talent for spotting winners. When markets rotated in 2022, he was overexposed to volatile sectors—and his portfolio took a heavy hit.

3. Endowment Effect

This bias causes people to overvalue something simply because they own it. We get emotionally attached to our holdings and struggle to let go.

Example: Like many employees, Daniel felt loyal to his company—and proud to own its stock. Over the years, he held every share that vested, even bought more through his 401(k), and never sold. It felt personal. He trusted the company. He worked there. Daniel’s emotional attachment made him ignore basic diversification principles. When the company hit hard times, his portfolio took a double hit: job risk and investment risk, both tied to the same place. It's a common mistake—failing to diversify employer stock because it feels like a sure thing (which would of course be driven by other biases, like overconfidence in your company’s prospects and your position to evaluate those prospects).

4. Status Quo Bias

Status quo bias is the preference to keep things the same, even when change would be beneficial. It can lead to inertia and missed opportunities.

Example: David set his investment portfolio ten years ago and never adjusted it. Even after a big promotion, marriage and kids, he avoided rebalancing or re-evaluating his overall plan. He stuck with his original plan not because it was still the best option, but because it was familiar—and change felt risky.

5. Regret Aversion

This is the tendency to avoid decisions that could lead to future regret—even if the odds favor action. Fear of being “wrong” paralyzes us.

Example: Julia was sitting on a big gain in a tech stock but worried that selling might mean missing out on more upside. On the flip side, she feared that if she held and the price dropped, she’d feel even worse. Her fear of regret led to indecision—and eventually, a missed chance to lock in profits.

Overcoming Biases: Build a System, Not a Perfect Mind

Biases aren’t flaws—they’re features of human thinking. But you can build systems that can help you account for them and prevent them from derailing your decisions.

- Start with a written investment plan. Outline your investment philosophy, goals, risk tolerance, time horizon, and criteria for buying or selling. This gives you a reference point when emotions run high.

- Use decision journals or checklists. Write down why you're making a move and what emotions or assumptions are at play. Revisit these notes months later to look for patterns.

- I have found it helpful to also seek out impartial academic and institutional studies that inform my overall investment approach (both supportive and critical), both in terms of theory and actual empirical evidence over extended time periods. This information has helped me to keep in check my biases that can lead to performance chasing and changing my investment approach without a solid basis.

- Most importantly, remember: awareness is powerful. You won’t eliminate these biases—but if you can spot them in action, you can pause, reflect, and pivot before they lead you astray.

Final Thoughts: Know Your Mind, Grow Your Wealth

Behavioral finance shows us that markets don’t just run on earnings and interest rates—they run on human behavior. By recognizing your own biases—informational or emotional—and creating systems to help you manage those biases, you place yourself in a much better position to achieve your long-term goals in investing.