Investment psychology: What is cognitive dissonance and how to reduce its impact? (2024)

Let’s dive deeper into the concept while making sure that it won’t affect your further investing decisions.

What is cognitive dissonance?

Cognitive dissonance refers to a situation when your beliefs, attitudes, or behaviors are inconsistent with one another. The inconsistency creates a feeling of discomfort or dissonance that you might seek to resolve.

For example, imagine you have always believed that investing in the stock market is risky. However, you recently made a significant amount of money by investing in a particular stock. This conflicting belief and behavior create cognitive dissonance, as the investor, your beliefs are not consistent with your actions.

How cognitive dissonance affects investment decisions

Here are a few examples of how cognitive dissonance affects investment decisions:

Confirmation bias

If you are experiencing cognitive dissonance, you may seek out information that confirms your beliefs, rather than seeking out information that challenges them. This behavior is known as confirmation bias and can lead you to make decisions based on incomplete or biased information.

Rationalization

You may also engage in rationalization to reduce your discomfort. For example, if you experience cognitive dissonance after making a poor investment decision may rationalize your decision by blaming external factors such as market conditions or company performance.

Inertia

You may also experience cognitive dissonance when faced with the decision to sell a losing investment. In this situation, you may choose to hold onto the investment rather than selling it, as selling would confirm your belief that you made a poor investment decision.

Minimizing the negative impact of cognitive dissonance

While cognitive dissonance can have a significant impact on investment decisions, there are strategies investors can use to minimize its negative impact. Here are a few strategies to consider:

Seek out diverse perspectives

One effective way to minimize the negative impact of cognitive dissonance is to seek out diverse perspectives. This can include seeking out information that challenges your beliefs, as well as seeking out input from other investors with different perspectives and experiences.

Be mindful of your emotions

If you are mindful of your emotions you are better able to recognize when experiencing cognitive dissonance. By recognizing these emotions, you can take steps to address them before making a decision.

Stick to your investment plan

If you have a well-defined investment plan, you are less likely to be swayed by cognitive dissonance. By sticking to a plan, you can avoid making impulsive decisions based on your emotions.

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Published: 29 Mar 2023, 08:21 AM IST