The human side of investing: how emotional biases distort financial decisions
The Sandbox Daily (10.21.2025)
Welcome, Sandbox friends.
Today’s Daily discusses:
how emotional biases distort financial decisions
Let’s dig in.
Blake
Markets in review
EQUITIES: Dow +0.47% | S&P 500 0.00% | Nasdaq 100 -0.06% | Russell 2000 -0.49%
FIXED INCOME: Barclays Agg Bond +0.10% | High Yield -0.15% | 2yr UST 3.455% | 10yr UST 3.961%
COMMODITIES: Brent Crude +0.84% to $61.52/barrel. Gold -5.37% to $4,123.4/oz.
BITCOIN: +0.81% to $111,638
US DOLLAR INDEX: +0.39% to 98.969
CBOE TOTAL PUT/CALL RATIO: 0.86
VIX: -1.97% to 17.87
Quote of the day
“Good decisions come from experience. Experience comes from making bad decisions.”
- Mark Twain
The human side of investing: how emotional biases distort financial decisions
Yesterday, we introduced the intersection between traditional finance and behavioral finance.
Traditional finance (TF) is grounded in neoclassical economics. Individuals are assumed to be “rational,” self-interested parties maximizing their utility. TF concepts may be thought of as normative, indicating how people and markets should behave.
In contrast, behavioral finance (BF) derives its core principles from psychology, and it attempts to understand and explain observed market behavior. BF concepts focus on how people and markets actually behave.
Theory vs. practice.
Rather than pretend emotions and biases and cognitive errors don’t exist, BF acknowledges their presence and how they can distort our decision-making process.
Through this lens, we understand the human experience includes both emotional biases and cognitive errors that result in decisions that may be suboptimal from a rational TF standpoint. This more nuanced perspective provides practical advice on how to better approximate the optimal results derived from TF.
While we will address both emotional biases and cognitive errors this week, today we focus on the former.
Emotional biases arise spontaneously as a result of attitude and feelings that can cause an investor’s decision to deviate from the rational decisions of TF. Because emotional biases stem from impulse or intuition – especially personal and sometime unreasoned judgments – they are less easily corrected.
We discuss the three most common emotional biases below:
Loss aversion bias: This behavior is the tendency to asymmetrically prefer avoiding losses over acquiring gains. It arises from feeling more pain from a loss than pleasure from an equal gain.
This behavior is consistent with the marginal utility of wealth, where a dollar is valued more (less) with decreasing (increasing) levels of wealth. A diversified multi-asset class portfolio should offer an approximately symmetrical return distribution. Under this condition, a rational investor would consider risk to be the uncertainty or volatility around the average expected return outcome. However, loss aversion suggests the investor weighs the negative returns differently than what the volatility around the expected return captures.
This bias can result in something called the disposition effect -> investors hold their losers too long and sell their winners too soon.
Status quo bias: This behavior occurs when comfort with the existing situation leads to an unwillingness to make changes, i.e. maintain the status quo. People are generally more content keeping things the same than with change, and thus don’t necessarily look for opportunities where change is beneficial.
In practice, investors will leave their asset allocation or individual positions alone despite changing market conditions or deviations in their own circumstances.
This leaves investors holding portfolios with inappropriate risk, or not considering other, better investment options.
The related “endowment bias” arises when an asset is felt to be so special and more valuable simply because it’s already owned. The intangible value assigned to the asset is unrelated to the current merits of the investment. Think of a widow who receives Coca-Cola stock from the deceased spouse and won’t move on from the position because he owned it for years and loved sipping Coke with his burgers.
Self-control bias: This behavior sees investors failing to act in pursuit of their longer-term, overarching goals because of a lack of self-discipline. There is an inherent conflict between short-term satisfaction and long-term restraint.
Money is an area in which people are notorious for displaying a lack of willpower, but it’s not the only one – attitudes toward exercise and smoking are similar in that regard. Short-term gratification conflicts with the discipline of long-term goals because the pain from sacrificing instant results in the present is much greater than an immeasurable payoff in some distant future.
This leads to insufficient savings accumulation to fund retirement needs and/or taking excessive risk in the portfolio to try and compensate for the shortfall.
Understanding our emotional biases allows us to confront the invisible forces shaping our financial behavior.
Recognizing these emotional biases is the first step toward mitigating their influence. By bringing awareness to our instincts, we move closer to making investment decisions guided not by impulse, but by intention.
Tomorrow, we’ll shift our focus to cognitive errors that also define BF and how portfolios can deviate from the optimal results of TF.
Source: CFA Institute
That’s all for today.
Blake
Questions about your financial goals or future?
Connect with a Sandbox financial advisor – our team is here to support you every step of the way!
Welcome to The Sandbox Daily, a daily curation of relevant research at the intersection of markets, economics, and lifestyle. We are committed to delivering high-quality and timely content to help investors make sense of capital markets.
Blake Millard is the Director of Investments at Sandbox Financial Partners, a Registered Investment Advisor. All opinions expressed here are solely his opinion and do not express or reflect the opinion of Sandbox Financial Partners. This Substack channel is for informational purposes only and should not be construed as investment advice. The information and opinions provided within should not be taken as specific advice on the merits of any investment decision by the reader. Investors should conduct their own due diligence regarding the prospects of any security discussed herein based on such investors’ own review of publicly available information. Clients of Sandbox Financial Partners may maintain positions in the markets, indexes, corporations, and/or securities discussed within The Sandbox Daily. Any projections, market outlooks, or estimates stated here are forward looking statements and are inherently unreliable; they are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.
Please see additional disclosures (click here)
Please see our SEC Registered firm brochure (click here)
Please see our SEC Registered Form CRS (click here)