To be a successful property investor it is critical to understand common human cognitive or psychological biases that often lead to poor decisions and investment mistakes. Due to the huge volume of information our brains have to process every day, we have evolved to take short cuts that sometimes cause us to make incorrect decisions without realising it. Below we outline some of the most common cognitive biases that are costing you money on your investment property.
Anchoring bias is the tendency to rely too heavily on, or anchor to, a past reference or one piece of information when making a decision. Consider that you have purchased a newly built investment property a year ago and it has recently been completed. At the time, the agent who sold you the property advised that you will receive $1000 a week in rent, and you have factored this $1000 a week into your budget calculations. However, all the offers you are getting from prospective tenants are $800 a week. What do you do? The obvious answer is to lease the property for the market price of $800 per week rather than leaving the property empty, but a huge proportion of people will hang on and try and wait in the slim hope that they achieve $1000 per week. This is anchoring bias.
Hindsight bias refers to the tendency of people to look at past events and believe that they were more predictable or likely than they actually were. Consider watching a sporting event where the underdog ended up winning convincingly, or a horse race where the outsider ends up winning the event. Despite the relatively small likelihood of that happened, after it has in fact happened people assign a higher probability to the event than would otherwise be the case. This causes issues with purchasing investment properties because if you have recently seen properties go up strongly in value you are likely to assume that this will continue happening in the future, potentially causing you to overpay. Similarly, you’re likely to be unaware how much of your wealth is tied up to the fortunes of a single property, in what is known as concentration risk.
Confirmation bias refers to the tendency to place an increased emphasis on information that confirms the views you already hold. Imagine you have been told before meeting someone that they are not a likeable person. When you do meet them, you are likely to put an increased emphasis on their negative traits (which we all have) that confirm your original opinion. The same can happen with property. If you naturally believe that property is a good investment, or you happen to own property, it’s likely that when you read good news you subconsciously value it more than negative news. Do you feel like a genius when property prices rise, but then discount when they fall as ‘just being the market’ or ‘property prices always rise in the long term?’ That’s confirmation bias.