Behavioural Finance: How Biases Shape Investing

Most Australians like to think of investing as a rational pursuit, a process of weighing risks, crunching numbers, and making clear-headed decisions. But research continues to show that the human mind doesn’t always behave rationally when money is involved.
In reality, our investment choices are often steered by subtle psychological forces, habits we barely notice, emotions we underestimate, and mental shortcuts that once helped us survive but now work against us in financial markets.

Behavioural finance, a field that merges psychology with economics, seeks to explain why investors often act against their own best interests. It shines a light on how biases influence everything from when we buy and sell shares to how we respond to market noise. Understanding these biases doesn’t just make you a more informed investor; it can make you a calmer, more consistent one.

When Fear and Loss Drive Decisions

One of the most powerful biases in investing is loss aversion, our instinct to avoid pain more strongly than we pursue pleasure.
Studies show that people feel the sting of a financial loss about twice as intensely as they feel the satisfaction of an equivalent gain. This means that losing $1,000 on a stock hurts far more than gaining $1,000 feels good.

In practice, this leads many Australians to hold on to underperforming investments for too long, refusing to sell in the hope they’ll bounce back. It also makes investors sell winners too quickly, locking in small gains before markets can grow further. During periods of market volatility (like the COVID-19 crash or the 2022 downturn) loss aversion has been one of the main reasons many retail investors sold at exactly the wrong time, missing out on the recovery that followed.

Overcoming loss aversion isn’t about suppressing fear, it’s about recognising it. Experienced investors often use long-term plans and automatic contributions to stay invested even when emotions say otherwise. By focusing on long-term goals, rather than short-term fluctuations, it becomes easier to ride out market turbulence without making costly emotional decisions.

The Confidence Trap

Confidence can be an asset in many areas of life, but in investing it often turns into a liability. Overconfidence bias makes us believe we know more than we do, that we can spot trends, time the market, or pick the next winning stock.
It’s a common bias in Australia, where a strong culture of independence and self-reliance sometimes encourages people to back their instincts over data.

But the evidence is clear: even professional fund managers struggle to consistently outperform the market. Retail investors who trade frequently, convinced of their insight, tend to earn lower returns than those who stick to a disciplined plan.
True investing confidence isn’t about believing you can predict the market; it’s about trusting your strategy enough to stick with it when uncertainty strikes.

The Comfort of the Crowd

Another habit that shapes our financial choices is the herd mentality, the urge to do what everyone else is doing. When property prices soar or a particular share starts trending, it’s easy to feel like you’re missing out. Social proof can make even risky investments look safe simply because others are doing the same.

Australian investors have seen this play out time and again, from the mining boom to the frenzy around tech stocks and cryptocurrencies. Herd behaviour drives many people to buy at the peak and sell when prices collapse, repeating a cycle that can quietly erode long-term wealth.

Resisting herd behaviour requires discipline and perspective. Instead of asking, “What is everyone else doing?”, it’s worth asking, “Does this fit my financial goals?” or “Would I still invest in this if no one else were talking about it?” Good investing often means feeling slightly uncomfortable, because genuine opportunities rarely come with a crowd cheering them on.

Anchors and Mental Shortcuts

Anchoring is another bias that quietly distorts decision-making. It happens when investors fixate on one specific piece of information (often the price they paid for an asset) and use it as a benchmark for all future decisions.
You might refuse to sell a share until it “gets back” to the price you bought it, even if the company’s fundamentals have changed completely. Or you might decide a stock is cheap just because it’s fallen from its previous high, ignoring the reasons behind the fall.

These mental anchors are comforting, but they can prevent investors from making rational, forward-looking choices. Experienced investors learn to detach from these anchors by focusing on present value and future potential, not on historical prices that no longer matter.

How to Outsmart Yourself

The goal isn’t to eliminate these biases, that’s impossible. They’re part of being human. The real challenge is to design systems that stop your emotions from hijacking your investments.

One powerful tool is automation. Regular, automatic investments into superannuation or diversified ETFs take emotion out of the equation. You invest consistently, whether the market is rising or falling, which smooths returns over time and stops you from trying to “time” the market.

Another approach is to set predefined rules, deciding in advance under what conditions you’ll sell or rebalance. When markets swing wildly, these rules provide a buffer against impulsive decisions.

Seeking an external perspective also helps. Financial advisers, or even a trusted friend who takes a more analytical view, can act as a behavioural guardrail, someone to challenge your instincts when you’re being driven by emotion rather than evidence.

Finally, education is key. Simply learning about behavioural finance can make a big difference. When you recognise patterns like overconfidence or herding in yourself, it becomes easier to pause and reflect before acting.

The Mind Behind the Money

In the end, the biggest risk to your investments isn’t market volatility, inflation, or interest rates. It’s your own behaviour.
Understanding how habits and biases influence your financial decisions can transform the way you invest. It helps you stay calm in chaos, rational in uncertainty, and focused on what truly matters: your long-term goals.

Investing success isn’t just about choosing the right assets; it’s about mastering your mind. Once you learn to manage your own psychology, the markets become a lot less intimidating, and your portfolio a lot more resilient.