Physiological Biases That Make Investors Become Irrational

1072 Words Nov 21st, 2014 5 Pages
Every single investment requires decision making. The result of decision making without certain planning might not end well. One cannot simply make a decision by relying on his/her personal resources as the decision may give an impact to the investments. It is difficult to make decision which is related to the field of investments. Investors have to consider their risks, market condition, rate of return, and others in making their investment portfolio. However, there are many possible physiological biases that make investors become irrational thus making bad decisions for the investment.
Illusion of Money
This bias refers to investors making decisions based upon nominal terms and not real terms. It means that the confusion between the
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Learn more about the historical average returns for specific investment.
Loss aversion
Loss aversion is most of the people fear of losing money than enjoy about potentially making money. For example, a stock may be down significantly from its purchase price, but investors holding back and hope that it will recover. Investors tend to react to immediate losses in stock funds by taking out the money from the funds, and thinking that reinvest when the equity market gets better. This decision will lead to the result buying high and selling low and lead to lower returns and higher risk. The solution for this is investors should focus on their goals and the overall returns in the portfolio than on the losses in an individual accounts, besides make sure the investment decisions are parallel with long term goals.

Representative
Some of investors might find representativeness to assist them in making judgments of investing because of the investors are being unsure of something about the portfolio (Tversky and Kahneman, 1974). Brahmana, Chee and Ahmad (2012) studied that investors insist to seek representative to make judgment regarding the probability between the samples drawn from a population. Investors tend to make decision based on their previous experiences (Jahanzeb, Muneer and Rehman, 2012). Besides that, they intend to make a mental shortcut which allows them to make decisions quickly (Cherry, 2013). This may lead to