5 Behavioral Biases That Are Destroying Your Investment Returns

Behavioral biases are the mental shortcuts and emotional reactions that cause investors to make poor decisions. Instead of relying on logic, people let fear, greed, or overconfidence guide their actions, buying high, selling low, or following the crowd. Over time, these biases quietly destroy investment returns by pushing investors to act impulsively rather than strategically.

We spent the better part of our time researching portfolios alongside investors, analyzing those that range from a few thousand dollars to tens of millions. And if there’s one thing I’ve learned, it’s that the smartest person in the room is often the one who makes the most irrational financial decisions. It isn’t about intelligence; it’s about psychology.

Just last quarter, I watched a seasoned executive with a stunning track record in business liquidate a perfectly good portfolio during a minor market dip. He was convinced a crash was imminent, armed with charts and what he called “irrefutable logic.” He wasn’t logical; he was scared. His fear, disguised as analysis, cost him an estimated six figures in recovery gains.

Let me show you the five most destructive biases I see week in and week out, and more importantly, how to stop them from derailing your financial future.

1. Loss Aversion: Why You Fear Losing $100 More Than You Enjoy Gaining $100

Here’s a simple truth: for most people, the pain of a loss is twice as powerful as the pleasure of an equivalent gain.This is loss aversion, and it’s probably the most powerful and costly bias in investing. I’ve seen it cause investors to hold onto declining assets for years, hoping to just “break even.”

The classic scenario I encounter is the investor who buys a stock at $50. It drops to $30. All rational analysis suggests the company’s fundamentals have changed for the worse, and it’s time to sell. But they can’t. The thought of “locking in” a loss is too painful. So they wait. And wait. Often, they ride it all the way down. Conversely, the moment a good investment shows a modest profit, they rush to sell, just to lock in the small win. This behavior—selling winners too early and holding losers too long—is a direct consequence of loss aversion.

How to Fight It:
The most effective tool I’ve seen clients use is to depersonalize the decision. Ask yourself: “If I had the cash equivalent of this investment’s value today, would I buy this exact stock with it?” If the answer is no, it’s time to sell. It doesn’t matter what you originally paid for it. That money is gone. Your decisions from this point forward should be based on future potential, not past mistakes.

2. Overconfidence: The Behavioral Bias That Tricks You Into Thinking You’re an Above-Average Investor

Most people think they’re above-average drivers, and funnily enough, a huge number of investors believe they’re above-average at picking stocks. Research from FINRA revealed that 64% of investors believe their investment knowledge is high. Yet, the data tells a different story.

For years, DALBAR’s annual Quantitative Analysis of Investor Behavior (QAIB) report has shown that the average investor consistently underperforms the market itself. Their 2025 report is no different, highlighting a significant gap between market returns and what the average equity investor actually achieved.[6] Why? Overconfidence often leads to two critical errors: excessive trading and inadequate diversification. You believe you can time the market or that your handful of stock picks are better than a broad market index.[7] This churns your portfolio, racks up transaction costs, and leaves you dangerously exposed when one of your “sure things” goes south.

Read our on the difference between AI investing and Human investing.

How to Fight It:
Embrace humility. The simplest strategy I’ve given to clients is to dedicate a small, limited portion of their portfolio say, 5% to their “genius” stock picks. The other 95% should be in a diversified, low-cost portfolio that aligns with their long-term goals. This gives them an outlet for their high-conviction ideas without torpedoing their entire financial plan.

3. Herding: Following the Crowd Off a Cliff

Remember the meme stock craze? Or the dot-com bubble? Those are prime examples of herding, a bias where investors mimic what the larger group is doing, assuming the crowd knows something they don’t.This instinct is deeply ingrained; in prehistoric times, following the herd kept you safe from predators. In modern markets, it often means you’re the last one in before a crash.

When I see a client suddenly desperate to buy into a hot sector that’s already seen massive gains, it’s rarely based on their own research. It’s because their coworker, their brother-in-law, or some influencer on social media is bragging about their returns. This is FOMO (fear of missing out) in action, and it’s a recipe for buying high and selling low. By the time an investment is popular enough for everyone to be talking about it, the biggest gains have likely already been made.

How to Fight It:
Create an investment policy statement. It sounds formal, but it’s just a simple document outlining your goals, risk tolerance, and the types of investments you will and won’t consider. Before making a trade, check it against your statement. Is this crypto asset or high-flying tech stock really part of your long-term plan, or are you just following the noise? This acts as a circuit breaker against impulsive, herd-driven decisions.

Herding: The Behavioral Bias That Makes You Follow the Crowd Off a Cliff

Anchoring is the tendency to rely too heavily on the first piece of information you receive. In investing, this often happens with a stock’s price. I once worked with a client who refused to sell a stock because it had previously traded at $200 per share. It was currently at $80, and its business model was fundamentally broken. But in his mind, its “real” value was $200, and he was anchored to that initial high-water mark.

This isn’t just about price. You might anchor to an old analyst report, a news headline, or the initial reason you bought the investment, even if circumstances have dramatically changed. This prevents you from objectively evaluating the asset based on today’s reality.

How to Fight It:
Always seek out fresh, contrary information. If you’re bullish on an investment, make a genuine effort to find the most intelligent bearish argument against it. This forces you to challenge your own assumptions and re-evaluate your position based on a full spectrum of information, not just the data point you anchored to months or years ago.

5. Confirmation Bias: Hearing Only What You Want to Hear

Confirmation bias is the natural tendency to search for, interpret, and recall information that confirms your existing beliefs. If you believe a certain company is the next big thing, you’ll subconsciously favor news articles, analyst ratings, and forum posts that support your view, while dismissing or downplaying any negative information.

I see this constantly in my work. An investor will come to me with a portfolio heavy in one particular sector, like renewable energy. They’ll present a folder of articles and research, all pointing to massive growth. What they don’t have is the data on competitive threats, regulatory risks, or valuation concerns. They didn’t ignore it on purpose; their brain filtered it out for them.

How to Fight It:
Appoint a “devil’s advocate.” This could be a trusted friend, a family member, or a financial advisor. Before making a significant investment decision, your job is to present your case to them. Their job is to poke as many holes in your argument as possible. This external challenge forces you to confront the evidence you may have subconsciously ignored and leads to a much more balanced decision.

Your Brain Isn’t Built for Markets, and That’s Okay

The human brain evolved to ensure survival, not to manage a 401(k). Our instincts for short-term safety, following the group, and fearing loss were incredibly useful on the savanna, but they are disastrous in financial markets.

Recognizing these biases is more than half the battle. The market will always be unpredictable, but your own behavior doesn’t have to be. By creating systems to counteract your innate psychological triggers, you move from being a reactive, emotional participant to a disciplined, strategic investor. And in my experience, that’s the only way to win in the long run.