Avoid these 5 biases to protect your investments

Avoid behavioural biases to navigate tough times

The ongoing market volatility would likely have triggered a sharp decline in your portfolio, making you question your investment decisions . But, this is the time to keep your emotions in check, as they can trick you into making poor decisions.

Be careful of behavioural biases — the psychological traps one falls into, especially when markets are down. Understand these biases and ways to overcome them to make sound financial decisions.

1. Herd mentality — following the crowd

Herd mentality is when we follow the crowd, believing everyone else must know something we don’t. This is common in investing, especially during times of excitement or panic.

In the past few months, crores of investors jumped into mid and small-cap segments, driven by FOMO (fear of missing out) and the hope of making quick gains. But, between September 2024 and February 2025, almost half of the 4,700 mid and small-cap stocks tanked more than 40 percent. Following the crowd without understanding the risks led to massive losses for hundreds of thousands of investors.

Don’t follow others blindly. Your financial goals and risk profile may differ from others. Always ask yourself:  does this investment align with my goals? Stick to your strategy and consult a professional to stay unbiased.

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2. Anchoring bias — sticking to the first information you get

Anchoring bias occurs when you latch onto the first piece of information you hear and let it shape your decisions.

A well-known example is when lakhs of investors held onto a famous housing finance company's stock simply because a famous investor had invested in it. Investors anchored their hopes on his decision. In 2018, the stock crashed over 40 percent in a single day, leaving the investors shocked. By 2021, the company was delisted, wiping out the remaining hopes.

Never anchor your investment decisions to someone else's moves, no matter how successful they are. Do your own research and due diligence before making decisions.

3. Overconfidence bias — thinking you can predict the market

Overconfidence bias is when you overestimate your knowledge or abilities. You believe you can predict the market or pick the best stocks, which leads to risky decisions.

A classic example is the bull market of late 2020. Investors thought they could consistently beat the market by picking trending stocks and many poured money into new-age companies and IPOs, confident they had picked well and were on track for big gains. But when the market corrected in late 2021, several of these stocks crashed more than 50 percent, wiping out hefty amounts of money.

Even the best investors make mistakes. The market is unpredictable. Stay humble. Consult a professional to ensure your investments align with your goals rather than over-relying on your judgement. Do remember,  even the best can't time the market.

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4 Loss aversion — the fear of losing

Loss aversion is a bias where the pain of losing money feels much worse than the joy of gaining it. Many investors fall into this trap when markets go south.

A prime example is how lakhs of investors held onto a once-famous private bank’s stock as it crashed over 90 percent between 2018 and 2020. Even after losing most of their hard-earned money, many are still hopeful that the stock will recover. This is the power of loss aversion — it makes you hold onto losers, fearing that selling would mean accepting defeat.

To avoid this, always ask yourself: is holding onto this investment in my best financial interest, or am I simply avoiding the pain of booking a loss? Sometimes cutting your losses is the smarter decision.

Also read: Midcap and smallcap volatility may persist, but stay the course with your SIPs

5 Endowment effect — overvaluing what you own

The endowment effect happens when you overvalue something just because you own it. This can be dangerous.

A recent example is when several investors followed a famous fund manager who praised certain "high-quality" stocks. Investors bought them at very high values. However, when the companies failed to match those values, the stocks corrected.

Yet, many held on to those scrips, believing that their “quality” would eventually pay off. This is the endowment bias in action. By the time the fund manager admitted the mistake, it was too late —many had already lost significant amounts.

Don’t hold onto an investment simply because you own it. Keep asking yourself: would I buy this stock today based on its current performance and prospects? If the answer is no, it’s time to reconsider.

When you are on a road trip along the way you see other cars speeding past you and are tempted to race them. But then you remind yourself that your goal is to reach your destination safely. Investing is the same. The market is full of noise, temptations, and distractions but your financial journey is unique. If you keep chasing after what others are doing, you risk losing control and missing your goal.