6 Behavioral Biases of Young Investors and How To Deal With Them
Aug 1, 2023
The CFA Institute and the Financial Industry Regulatory Authority (FINRA) surveyed more than 2000 young people in the US, China, Canada, and the UK. They found that 56 percent of those under 25 (Gen Zs) are already investors, with 80 percent beginning their journeys before hitting 20. In comparison, only a fourth of millennials and 14 percent of Gen Xs started younger than 20, making Gen Zs the most investment-savvy generation of all.
The world of investing has indeed changed a lot. Armed with unprecedented access to information and trading platforms, these young investors have the potential to shape their financial destinies. However, beneath the veneer of technological prowess lies a complex web of behavioral biases that can sway their investment decisions.
Understanding the behavioral biases of young investors is paramount in empowering them to navigate the financial landscape successfully. This article sheds light on six behavioral biases that frequently impact the investment choices of the youth.
1. Fear of Missing Out (FOMO)
In the digital age, young investors are constantly bombarded with news of market trends, hot stocks, and lucrative opportunities. The fear of missing out (FOMO) breeds impulsive actions as they rush to invest in the latest trend without proper research or understanding.
Cultivating discipline and patience is essential to counteract the effects of FOMO. Young investors should conduct thorough research before making investment decisions and resist the urge to chase short-term gains. Sticking to a well-thought-out investment plan can help build a solid foundation for long-term success.
One of the most pervasive biases among young investors is overconfidence — a tendency to believe that their skills and knowledge surpass those of their peers and the market. According to a study, investors aged 18 to 34 tend to be more confident than those between 35 and 54 and even those older than 55.
Armed with abundant information at their fingertips, young investors might feel that they can outperform professional investors or beat the market consistently. As a result, they may engage in risky investments without fully comprehending the potential consequences.
Education and awareness are crucial tools to combat overconfidence. Young investors should focus on developing a long-term investment plan, diversifying their portfolio, and seeking advice from experienced professionals. Accepting the limitations of one's knowledge and expertise can help avoid impulsive decisions.
3. Anchoring Bias
Anchoring bias is a person's inclination to rely substantially on the first piece of information encountered when making decisions. Young investors might anchor their expectations based on past performance or stock prices, making it challenging to adjust their perceptions as new information emerges. This potential difficulty can lead to holding onto investments for too long, even when the fundamentals have shifted.
Developing a systematic approach to investment analysis can help counteract the anchoring bias. Young investors should regularly reassess their portfolios, stay up-to-date with relevant news, and be open to adjusting their strategies based on changing market conditions.
4. Loss Aversion
According to a long-held belief among experts, the pain we feel from a loss is twice as intense as the joy of its equivalent gain. This theory may explain why not only young investors but all investors are affected by loss aversion as a psychological bias.
Going by logic, loss aversion is often more pronounced among young investors who may not have experienced significant market downturns. This bias describes the tendency to fear losses more than we value gains, leading young investors to avoid selling losing positions even when it might be a rational decision.
Through risk management strategies like setting stop-loss orders or defining exit points for each investment, the impact of loss aversion can be reduced. Additionally, young investors should focus on the overall performance of their portfolio rather than individual stocks or assets, helping them maintain a broader perspective on their investments.
5. Confirmation Bias
Confirmation bias is a person's tendency to seek or value information that aligns with their existing beliefs while disregarding contradictory evidence. In the realm of investing, young investors may gravitate toward sources that validate their investment choices, leading to poor critical evaluation and potential risk oversight.
Diversifying information sources and actively seeking out differing viewpoints can help mitigate confirmation bias. Engaging in discussions with peers and professionals with different perspectives can also encourage a more well-rounded approach to decision-making.
6. Herd Mentality
Between 1692 and 1693, hysteria broke out in a small colonial Massachusetts town as a group of young girls accused several women of practicing witchcraft. Soon, the entire village was gripped with fear as more women were accused of witchcraft, leading to 59 deaths and over 200 people tried and imprisoned without evidence. The Salem Witch Trials went down in history as one of the most profound examples of herd mentality.
The prevalence of social media and online investment communities can exacerbate herd mentality among young investors today. Herding behavior involves mimicking the actions of others, often without conducting proper due diligence. The desire to be part of a community or to avoid the fear of missing out can lead to a clustering effect in certain investment choices.
Young investors should remember that markets are not always rational, and herd mentality can lead to price bubbles and sudden collapses. Conducting independent research and basing investment decisions on sound analysis rather than groupthink can help steer clear of the negative consequences of herding behavior.
Understanding and navigating the behavioral biases influencing young investors is essential to building a solid financial foundation. By recognizing these biases and employing effective mitigation strategies, young investors can develop a disciplined and rational approach to investing.
Education, continuous learning, and seeking advice from experienced professionals are critical to overcoming behavioral biases. Embracing a long-term perspective and focusing on the fundamentals of investments can help young investors weather market fluctuations and achieve their financial goals.