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Behavior and Investing: 7 Ways To Control Emotional Biases

Jake - Author/Founder

Hi. I'm Jake, a frugal Canadian Engineer. I believe you can build a great life through frugal living and index investing.

Let’s begin with two lies

Lie 1. The most important trait of a successful investor is technical know-how. 

Lie 2. The investor must be good at fundamental analysis, industry assessment, and forecasting future trends in technology to get good returns.

I once thought both lies were true. But I was wrong. You can be a great investor without any of these skills. 

Instead, your largest investing obstacle can be found in the mirror. 

I know this can suck to hear. It’s hard on the ego. 

But the most important part of investing is accepting emotional biases. That requires humility. The second hardest part is controlling these biases over the long term.

I think this is cool because you don’t need to be the brightest bulb on the block to succeed as an investor. Self-control and humility will get you much further. 

My confidence in this viewpoint only strengthens as my experience as an investor grows.

Emotional Biases Erode Returns

All of us are susceptible to emotional biases. You, me, everyone. 

Common emotion-driven actions include overtrading, return chasing, panic selling, and herding into meme stocks and coins. 

Each of these behaviors interrupts compounding. Even the world’s best investors would be failures without the ability to mitigate their human biases.

And to those who believe they are immune to these biases, they suffer from the overconfidence bias.

Investing Is Simple, But Hard

The data and academic literature are clear on the ideal long-term investing approach.

Buy and hold low-cost index funds. Simple, but hard. 

Index funds allow you to gain the market return for a fee that is less than 0.2%. These funds are proven to beat over 80% of professional fund managers. Further, index funds also beat DIY investors, who underperform due to emotional biases.

The technical side of investing in index funds is simple. The hard part is keeping your emotional biases on a leach during the stormy ups and downs of the market.

Table of Contents

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Investment Risk: A Crash Course

What is Risk?

Risk is the likelihood of loss. It is commonly defined as volatility – the intensity of ups and downs in an asset’s price. It’s how rapidly you gain or lose money in the short term. 

The definition of risk is a bit more complex when you consider longer time horizons.

How to Change Your Risk Exposure

Some asset classes are riskier than others. For example, stocks are riskier than bonds, and bonds are riskier than cash. 

The neat thing is that you can engineer your risk exposure by selecting a mix of these assets in your portfolio. 

Risk Tolerance: How Much Risk Can I Take?

The amount of investment risk you can take is unique to you. Take on too much risk, and you may end up working at K-Mart until your 75. 

But if you fail to take enough risk, you may not meet your money goals.

Your overall risk exposure is a balance that depends on two key factors: 

1. Your ability to take on risk: Determined by circumstances like your age, time horizon, and income stability.

2. Your willingness to take on risk. How well you sleep at night. Your ability to control your emotional biases improves your willingness to take risk.

The Risk Return Relationship

You are paid for taking on risk. Risky assets have higher expected long-run returns. Stocks have higher expected returns than bonds, and bonds provide higher returns than the interest on cash savings.

How does this relate to emotional biases?

Well, you’re willingness to take risk increases when you can control your emotional biases. In turn, you can invest in assets with higher long-term returns :). 

Learn more about investment risk and consider your unique risk tolerance by reading Investment Risk and Risk Tolerance: An Introduction. 

Investing in Stocks: An Emotional Rollercoaster

The stock market is an emotional roller coaster. We get most excited and overconfident at market highs and most pessimistic and fearful at market lows. 

Human emotions (including mine) urge us to buy after a strong performance and to sell in the depth of crashes. These actions interrupt the compound effect at the worst possible times. Very sad. 

Stock Market Emotional Control Infographic

Understand Human Biases

The first step to control emotional biases is to understand them. Once the biases are understood, you are set to protect yourself from yourself.

Willpower alone is not enough. You need to avoid situations that trigger the biases. It’s hard not to drink at an open bar. 

For example, suppose there is chocolate on my kitchen counter. I will eat the chocolate – I do not have the discipline to leave the chocolate alone. Instead of relying on discipline, I avoid buying chocolate in the first place. I’ve acknowledged my bias and have protected me from me. 

Alright, let’s dive into three of the most important human biases. Note that these biases feed on each other. This is super interesting, and it adds complexity. 

Herd Behavioural Bias (Bandwagon Effect)

We have a tendency to conform to what everyone else is doing. Research indicates that we have deep biological desires to conform for two reasons:

  • We believe the group is better informed than we are. 

The group may be better informed in some situations in life, but investing is not one of them. 

Warren Buffett knows this well. He even has a saying to describe herd behavior. 

“Be fearful when others are greedy, and be greedy when others are fearful”. 

Infographic - Herd Behaviour

What History Teaches Us About Herd Behavior

Herd behaviour can be seen through history’s speculative manias.  During these manias, people bid up asset prices and everyone gets rich quick. This often occurs during the adoption of new technologies, where we overestimate how quickly technology makes change. 

Herding behavior can be seen when looking back in history. Examples include the Tulip Mania, the South Sea Bubble, the Dot-Com bubble, and the run-up to the 2008 U.S. housing market crash. Recently, we’ve seen herding episodes for various cryptocurrencies and meme stocks. 

Good investors ignore, and often go against,  social conformance pressure. The best stock pickers like Peter Lynch and Buffett advocate for boring anti-hype companies, sometimes even in declining industries. 

Loss Aversion Bias

A loss hurts more than an equivalent gain is pleasurable. A $100 loss is about twice as painful as a $100 gain is pleasurable. You can read into the literature here.

Loss aversion drives the desire to sell during market crashes and to hold on to items we own – the Endowment Effect. 

Infographic - Loss Aversion

Panic Selling Example

Let’s look at Joe. In 2008, Joe has fully invested in the MSCI All Countries World Index. Joe lost over 42% of his investment value that year. Joe’s emotions were screaming “sell” in fear of further loss.

But Joe knew this was the worst time to sell and that it was a time of maximum expected returns. Joe felt loss aversion but did not act on it. Try to be like Joe (it’s hard). 

Loss Aversion: Fear of Missing Out (FOMO)

Suppose you see a group of friends making money on a hot stock. You’re missing quick returns, and that hurts. 

Even worse, you feel social pressure from your group of friends. Plus, a loss won’t feel so bad because everyone will be losing together.

So you jump into an over-valued asset at the worst possible time (with the lowest expected returns) to alleviate this pain of FOMO. Fear of Missing Out (FOMO) is a form of loss aversion that can cause you to buy high.  

Overconfidence Bias

The stock market is a complex system, with many interdependent variables that cause chaotic, random behavior. We tend to underestimate randomness and overestimate our predictive abilities. 

This tendency is strongest after long runs of returns. We also attribute higher predictability to outcomes when looking back at history – the well-known hindsight bias.

Infographic - Overconfidence Bias

Overconfidence can cause over-trading and the acceptance of excess risk to satisfy get-rick-quick urges. 

An interesting example of the over-confidence bias is when dealing with your friends. You’ll only hear about the “wins” and they likely won’t tell you about their losses. This is particularly common with options traders. Be careful when listening to the success stories put forward by others.  

Some Books on Human Biases

The book Thinking Fast and Slow by Daniel Kahneman covers human biases extremely well. Another great (but long) book is The Laws of Human Nature by Robert Greene. 

7 Ways to Control Emotional Biases

1. Proper Asset Allocation

One way to protect yourself from yourself is to engineer portfolio risk by changing the mix between stocks, bonds, and cash. 

This mix is called your “asset allocation”. 

Bonds can make your portfolio less choppy, at the expense of long-run expected returns. Alternatively, stocks can make it more volatile while increasing expected returns. 

You can estimate your rough asset allocation using Vanguard’s Investor Questionnaire.

Bonds barely beat inflation, however, they can serve as an emotional buffer that improves your likelihood of holding out stock market crashes. 

Bonds can contribute to higher returns through their positive psychological influence. 

2. Eliminate Non-Systemic Risk

Globally diversified indexed funds minimizes all the risk that you don’t get paid for. This gives you the highest returns with the lowest possible volatility. 

This is why Burton Malkiel calls global index investing the closest thing to a free lunch in his fantastic book A Random Walk Down Wall Street.

3. Keep it Simple, and Boring

Simple portfolios require less tinkering. Less tinkering means you can emotionally detach from your portfolio. Plus, you’ll have more time to spend on the important things in life. 

I gain my excitement in life from other sources – not investing. Boring one-fund solutions like or XEQT make access to global stocks as simple and cheap as possible for Canadians. Similarly, VT allows Americans to access global stocks for cheap. For those who have a bond allocation, check out the Canadian Couch Potato Model Portfolios.

Global index investing is so boring that you’ll have limited desire to check and tinker with your portfolio.

4. Don’t Check Your Portfolio Often

I have a hard time with this one – it’s exciting to see the value of your portfolio change from day to day. 

But daily fluctuations in portfolio value are irrelevant if you have a long time horizon. All they do is increase the emotional response to short-term changes.

If you check your portfolio at a lower frequency, you can

This makes it harder to detach emotionally. You’re investing for a time horizon of decades, not weeks. 

5. Understand Your Investments and Where Returns Come From

Understanding the basics of where stock returns come from helps you keep calm in the face of volatility. It can even help you view a downturn as an opportunity because you know that you are paying less for future cash flows of the businesses you own. 

The price of a stock is based on the future earnings power of the business. As an owner of the company, you get to share in the earnings via dividends or share buybacks.  

By owning a basket of stocks with an indexed fund, you share in the aggregate earnings growth and dividends of all the businesses. This, in short, is where returns come from. 

6. Avoid Stock Market News

Stock market news is terrible. No one can predict what will happen in the market, including the experts. I don’t understand how these folks retain confidence after routinely failing in their predictions. 

Further, news is primarily negative and is likely to trigger loss aversion that makes it harder to hold through downturns. 

7. Build Strong Systems - Invest Consistently

Systems and habits remove reliance on willpower and reduce the influence of your human biases. This is why pilots use checklists, and it’s why aircraft technicians have someone conduct an independent review of their work. The book Atomic Habits stresses the importance of solid systems and habits over goals. 

Let’s go through some examples of systems. This is important. 

Investment System - Example 1 - Jake's System

I’ll share my system with you.

I invest in 6 specific index funds that provide geographic exposure to thousands of stocks. My portfolio structure is pre-set, with specific allocations to different geographic regions. I follow the portfolio regardless of what is going on in the markets. 

I let my savings accumulate over 4 paychecks and invest every two months. This system rids parasitic attempts to time the market, and improves my habits. I’ll naturally catch the highs and the lows of the market – a nice emotional buffer. 

Investment System - Example 2 - Automation

Even better, you can automate your investments to have a set amount transferred from your chequing account to a brokerage account. From here you can have the money automatically invested in an index fund.  This is called forced savings (with automated investing). 

The coolest thing about forced savings + automated investing is that one simple decision can set you up for long-term financial success. It allows anyone to statistically beat the returns of most (professional) investors while reducing the effects of your emotional biases. 


  • Humans have behavioral biases that result in poor long-term performance if left uncontrolled. 
  • If you want higher returns you need to take on more risk. Greater emotional control is needed to ride out the ups and downs associated with greater risk. 
  • You can limit emotional decision-making by understanding human biases, global index investing, proper asset allocation, and discipline. 
  • There are other non-behavioral factors that affect your risk tolerance such as your human capital and time horizon.