Q: Which of our behavioral biases do the most damage to our financial well-being?
There are many failings that get us into trouble financially, as I describe in Misbehaving, so let me focus on just two.
The first is loss aversion. Losses have about twice the emotional impact of an equivalent gain. Fear of losses (and a tendency toward short-term thinking—I'm sneaking in a third one here) can inhibit appropriate risk-taking
For example, investing in the stock market has historically provided much higher returns than investing in bonds or savings accounts, but stock prices fluctuate more, producing a greater risk of losses. Loss aversion can prevent investors from taking advantage of the long-term opportunities in stocks.
The second bias that causes a lot of trouble is overconfidence. Most people think they are above-average investors, and as a result they trade too much and diversify too little. Overconfidence can also lead people to invest during what appears to be a bubble, thinking they will just get out faster than others. Research shows that the more individuals trade, the lower their returns. Not surprisingly, men suffer from this problem more than women.
This is one of the many reasons why it would be better if we had more women as portfolio managers.