When it comes to investing, we are convinced that the main enemy is the market: crises, inflation, interest rates, wars… Yet often, the most dangerous enemy is the one staring back at us in the mirror.
Behavioral finance, developed through the research of Daniel Kahneman and Amos Tversky, has shown that our brains make thousands of decisions every day and, to save time and energy, rely on mental shortcuts to process information quickly. These shortcuts, useful in everyday life, can become dangerous when we have to make important financial decisions.
Let’s look at some of the most common cognitive biases: learning to recognize them is the first step towards preventing them from influencing our decisions.
Loss Aversion
Losing €100 has a greater psychological impact than gaining the same €100. Research has shown that the pain of a loss is, on average, about twice as powerful as the pleasure of an equivalent gain.
This mechanism, known as loss aversion, leads to two opposite but equally damaging mistakes when it comes to managing one’s wealth:
- The “anchoring effect“: holding on to a stock that has suffered significant losses, hoping it will “return to its purchase price”, rather than selling it and reallocating the capital to better opportunities.
- Excessive caution: keeping all your savings in a current account for fear of seeing your capital fluctuate, while allowing inflation to erode its value day after day.
Herd Mentality
“If everyone is doing it, it must be trustworthy“: this is a phrase that comes naturally to us because we are social animals and, for thousands of years, following the group has ensured our survival. This is what is known as herd mentality (or herding): the tendency to imitate other people’s decisions, either out of fear of missing an opportunity or of being left out of a potential gain.
It is important to remember that the popularity of an investment is no guarantee of its quality. History has taught us this lesson: the dot-com bubble of the late 1990s, subprime mortgages, and cryptocurrencies that have surged and crashed several times.
The mechanism is always the same: prices rise, the media start talking about it, friends and colleagues share stories of easy profits, and the fear of missing out (the so-called FOMO, fear of missing out) drives people to invest precisely when prices are already high. Then, when the trend reverses, that same crowd rushes for the exit.
Overconfidence
In surveys, most people consider themselves “above average” as drivers, employees and, of course, investors. This is statistically impossible and is a sign of widespread overconfidence: many investors tend to overestimate their skills, their knowledge and, above all, their ability to predict the future direction of the markets.
When several consecutive investments turn out well, perhaps due to luck or because the market was in an upward phase, the brain tends to attribute all the credit to its own abilities.
This leads to taking excessive risks: concentrating too much money in a single stock, trading too frequently, or ignoring expert opinions.
Understanding Cognitive Biases Is Not Enough: You Need a Method
Knowing that these biases exist is a first step towards greater financial awareness. However, they are deeply ingrained automatic responses that tend to kick in under stress. That is why the best way to protect yourself is to invest using a consistent, rational method.
This is where a financial advisor can make a difference.
At Team Paperetti, we support our clients in precisely this way: together, we develop a clear plan aligned with their goals, investment time horizon and risk tolerance. We then remain by their side when market conditions put investors’ resilience to the test.
Because in finance, the best returns often come not from doing the right thing at the right time, but from avoiding the wrong thing at the wrong time.
Get in touch with us to start your financial advisory journey together!