The impact of Cognitive Biases & Psychological errors on investment Decision-Making: An Analysis of Behavioral Finance Dynamics

Given that investing is a highly competitive field where choices can make or break an investor, it is vital to be able to make rational decisions. However, investors fail to consider one of the most crucial aspects that affect decision-making: Cognitive biases & Psychological errors, in other words, how the mind works and makes decisions, These heuristics and mental frameworks that are perfectly suitable for our daily lives, can cause systematic irrationality when applied to the highly unpredictable financial markets. Cognitive biases are the mental shortcuts that help in quick decision-making but at the same time distort the way we think. These biases may cause investors to underestimate risk, overestimate the value of specific pieces of information, or mimic market trends when making investment decisions. Instead of cutting losses and reallocating the funds more wisely, an investor may, for example, keep a bad stock due to sentimental attachment or because he/she believed that the price would recover shortly. These biases are particularly dangerous when it comes to investing because they often operate at an unconscious level, making investors make decisions that they believe are right but are wrong. Psychological errors, on the other hand, stem from more profound psychological dispositions and propensities. These are the fear of loss, the desire to follow others, and the tendency to repeat what has been done before. When these errors are made, they can intensify the impact of cognitive biases and result in decisions based more on emotion than on logic. For instance, Fear of Missing out (FOMO) can make investors rush into purchasing assets that have been hyped and hence, investing at higher prices than they should, while loss aversion can make investors avoid certain investments due to fear of losing the little that they have. This paper will also compare the various cognitive biases and psychological fallacies that affect the investment decision making. In this essay, the focus will be on how these mental biases impact the investment process; the research and analysis stage and the execution stage. Besides, we will also consider how these biases can be prevented and how the proper decision-making sequence should be implemented, the function of data, and how the long-term orientation should be considered. In this way, the psychological factors that affect investment decisions can be used to increase investor’s awareness and enhance the ability to make more rational decisions. In conclusion, this paper aims at providing information that will enable investors in the global financial markets to be more rational and efficient in their decisions hence reducing the impacts of cognitive biases and psychological fallacies on their decisions made while investing.