The Emotional Biases that Drive Us


Investor Jim O’Shaughnessy said that “human nature is the last sustainable edge” due to its remarkable consistency over thousands of years. We may no longer be trading tulips in Amsterdam or speculating on the ticker tapes in bucket shops, but from a behavioral and emotional standpoint, we do not act differently than our forefathers.


We’ve never had a new client tell us they are short-term investors who are extremely fickle and skittish. In fact, they are “always” self-proclaimed long-term investors…until they start seeing short-term unrealized losses. That’s when their emotional biases begin taking a strangle hold. So much of our world view is shaped by our own emotional biases. These are especially on display during volatile markets.  

First, when it comes to investing and financial planning, it’s important to understand that emotional biases differ from cognitive errors.

Cognitive errors are primarily due to faulty reasoning and generally stem from a lack of understanding of math, statistics, or accounting. Sometimes they may stem from memory errors. Importantly, these cognitive errors are rational and can be generally mitigated through learning, education, or training. 

Emotional biases are not related to conscious thought and stem from feelings or impulses or intuition.

They are not rational. These are very difficult to overcome or change. In his book Succeeding, John T. Reed writes, “When you first start to study a field, it seems like you have to memorize a zillion things. You don’t. What you need is to identify the core principles – generally three to twelve of them – that govern the field. The million things you thought you had to memorize are simply various combinations of the core principles.” I would argue that one of those core principles in personal finance is self-control and the ability to emotionally detach. Let’s dive into the most common emotional biases we see.

Self-control bias occurs when individuals lack self-control and favor immediate gratification over long-term goals.

Self-control bias is evident when there is a conflict between short-term satisfaction and long-term goals. Often, individuals are not prepared to make short-term sacrifices or put up with short-term discomfort or uncertainty to meet their long-term goals. Think about this in another field: exercise and physical fitness. Believe it or not, there are no shortcuts to peak physical fitness. It requires daily discipline and pain. Compounding wealth is the same way. Long-term compounding is full of short-term setbacks. As Warren Buffett just wrote in his February 25, 2023 annual letter, “I have been investing for 80 years – more than one-third of our country’s lifetime. Despite our citizens’ penchant – almost enthusiasm – for self-criticism and self-doubt, I have yet to see a time when it made sense to make a long-term bet against America. And I doubt very much that any reader of this letter will have a different experience in the future.”

Endowment bias occurs when an asset is felt to be special and therefore more valuable, simply because it is already owned.

We see this frequently with inherited assets. For example, when a child holds on to the securities their deceased parent purchased for sentimental reasons that are unrelated to their current merits as investments. If these holdings represent a significant concentration issue (lack of diversification), it may be advisable to slowly diversify away from those holdings, as painful as it may be. 

Overconfidence bias occurs when individuals overestimate their own intuitive ability or reasoning.

It can show up as an illusion of expertise where they think they do a better job of predicting or forecasting than they actually do. Individuals who may have been extraordinarily successful in another career field project this confidence into other areas of which they have little understanding or experience. As an extension of this bias, individuals will take personal credit when things go right (self-enhancing) but blame others or outside circumstances for failure (self-protecting). Overconfidence bias is extremely difficult for individuals to correct and is rooted in the desire to feel good. It’s hard to make dramatic mistakes in a raging bull market even if the underlying decision-making that led to the investment was faulty. The danger is that the investor views these gains as evidence of his or her superior decision-making ability rather than just rising tides lifting all boats. 

Loss aversion bias refers to the emotional bias where people feel the pain of losses more strongly than the pleasure of gains.

It is the tendency to prefer avoiding losses over acquiring equivalent gains. This bias can influence people’s decision-making, causing them to take actions to avoid losses rather than pursue gains. In investing, loss aversion bias can lead people to hold onto losing investments for too long, hoping that they will eventually recover, even though it may not be rational to do so. This can lead to missed opportunities to invest in more promising investments and can result in significant losses.

Regret aversion bias is an emotional bias that refers to the tendency of individuals to avoid making decisions that they fear may lead to regret or disappointment in the future, even if those decisions have a potentially greater reward or benefit.

As we all know, making no decision is a decision in and of itself. People who exhibit regret aversion bias tend to be risk-averse, as they are more focused on avoiding negative outcomes than they are on achieving positive outcomes. They may be hesitant to make decisions that involve uncertainty or potential risk and may prefer to stick with the status quo or take a conservative approach. Consequences and implications of regret-aversion generally include excess conservatism in the portfolio because it is easy to see that riskier assets do at times underperform or exhibit volatile traits. Therefore, individuals that display regret aversion bias do not buy riskier assets because they won’t experience regret if they decline.

Status quo bias is a cognitive bias that refers to the tendency of individuals to prefer things to remain the same and to be resistant to change.

This bias can influence decision-making, as people may be more likely to stick with familiar options, even if there are better alternatives available. In investing, status quo bias can manifest itself in a number of ways. For example, an investor may be hesitant to sell a stock that they have held for a long time, even if the stock’s performance has been poor and there are better investment opportunities available. This may be because the investor is attached to the familiar stock and is resistant to making a change. Another example of status quo bias in investing is when an investor sticks with a particular investment strategy, even if it is no longer performing well or is no longer appropriate given the investor’s current financial goals or risk tolerance. The investor may be resistant to making a change because they are comfortable with the familiar strategy and do not want to take on the risk of trying something new.

These emotional biases are not mutually exclusive—and in fact, sometimes it’s not a clear distinction between where one type of bias ends and another one begins given that some tend to work in tandem with one another. While they are pretty difficult habits to kick due to their often subconscious nature, awareness of them is a critical first step in fighting them.

Self-control is an undervalued factor that will ultimately set apart the most successful investors from the rest of the herd. 

Dylan Potter

Dylan is a partner, Vice President and Wealth Manager at Howe & Rusling.


Get the latest content from Beyond the Bell