Money psychology: cognitive errors that make you lose money

Loss aversion is the most powerful bias in personal finance. Kahneman and Tversky's studies demonstrated that people feel the emotional impact of a loss approximately twice as strongly as the pleasure of an equivalent gain. This explains seemingly irrational behaviors: we prefer not to lose €100 to gaining €100, leading us to avoid reasonable risks that could benefit us.

In practice, loss aversion manifests in two harmful ways. First, we sell rising investments too soon ('weak hands' effect) to secure small gains. Second, we hold falling ones for too long, hoping they recover so we don't have to accept the loss. The result is a portfolio full of losers and empty of winners.

Confirmation bias leads us to seek, interpret, and remember information that confirms our prior beliefs, ignoring what contradicts them. If you have bought shares in a company, you will tend to read only positive analysis about it and dismiss warnings as 'exaggerations.' This bias blinds us to clear sell signals and traps us in bad investments.

The endowment effect makes us overvalue what we own simply because it is ours. The same object seems more valuable to us when we have it than when we don't. This explains why it is so hard for us to get rid of inherited investments, gifts, or old purchases that no longer make sense in our current portfolio. 'It's mine, it has sentimental value,' we think, even though objectively it is a bad investment.

The anchoring bias ties us to irrelevant numerical references for the current decision. The classic example is the price at which you bought a share: you obsess over 'recovering your investment' and refuse to sell at a loss, even if the company has fundamentally deteriorated. The purchase price is water under the bridge: the only thing relevant is the expected future value, not what you paid in the past.

Herding or the bandwagon effect pushes us to do what everyone else does, assuming the crowd is right. When everyone is buying cryptocurrencies, tech stocks, or real estate, we feel FOMO (fear of missing out) and enter late and expensive. When everyone sells in panic, we sell too, realizing unnecessary losses. The best opportunities usually appear when the majority is fearful, and the greatest risks when everyone is euphoric.