Investor bias – knowledge is power

Downward Trend ChartFor all our intelligence, humans can be remarkably irrational – and, worse still, fail to realise the fact.
 
Common cognitive biases can get in the way of clear and considered decision making when it comes to all facets of life, including real estate investment.
 
It’s difficult to completely rid your mind of such biases but, by being aware of them, you might be able to take a more critical approach.
 
Here are some common biases and their potential effect when it comes to property investment:
  • Recency bias – the tendency to believe what happened most recently will happen again – can tempt investors into the market as it nears a peak because they believe recent rises will continue.
  • Sunk cost fallacy – investors who plough on with a sub-standard investment because of the money/time/energy they have already spent are victims of this flaw, unless there’s good reason to believe the situation will change.
  • Confirmation bias – we’re more likely to be attracted to, and absorb, information which confirms what we already believe, and to discount conflicting views. This can lead us to disregard relevant information.
  • Status quo bias – wanting to continue down the path you’re already on, even if a different path might be better. Investors may, for example, continue to invest only in family houses with land in a certain state, ignoring opportunities offered by units elsewhere.
  • Bandwagon effect – peer pressure can push investors to get into property or other investments which don’t suit their individual risk profile because “everyone” else is doing it. Clever investors can use the bandwagon to their advantage by going against the crowd.
  • Neglecting probability – some investors take a “she’ll be right” approach without properly and realistically considering the risks they face, or taking steps to address them with proper insurance and risk management.
  • Anchoring effect – valuing something in comparison to something else rather than on its own, independent merits. For example, you might think apartment B is a bargain because it’s less expensive than apartment A – even if it’s actually still overpriced.
  • Positivity and negativity – if you’re overly negative you may fall into “analysis paralysis” and never invest for fear, but a positivity bias can be just as dangerous with the risk of leaping into an ill-thought-out investment or sticking with one that’s failing to perform.