Many of my former business class students at university snickered at anyone studying psychology, considering it an easy discipline. Big mistake. Business students learn only too late they should have attended a psych class or two because investment success and market direction are often more closely tied to psychology than they are to economics.

Take the recession of 2008. Sure, there were big financial problems, but it was fear that drove the runs on the banks and caused even more financial issues and markets to suffer.

Investors need to be careful of behavioural biases that can hurt their investment returns. Mario Mainelli, in the May 2012 issue of Canadian MoneySaver, explains four biases to watch out for. We have summarized them here, and show you how to catch yourself when you fall into one of their traps:

CONFIRMATION BIAS

Investors displaying confirmation bias look only at the information that confirms their beliefs and ignore any information that contradicts it. This can lead to investor overconfidence, and in some situations an under-diversified portfolio or an unjustified purchase decision.

Confirmation bias is particularly difficult to overcome when examining stocks already owned. "You may be more likely to ignore negative information on a stock you own because you simply refuse to believe you may have made a bad purchase", Mainelli writes.

To counter this bias, gather as much information as possible and make a special effort to note contradictory arguments.

FAMILIARITY BIAS

There is no correlation that connects the distance of an investor to a stock exchange with the chance of investment success. But Canadian investors still tend to stuff their portfolios with domestic stocks and bonds. This is a particularly painful decision these days, because weak commodity sectors have meant the TSX has fared poorly compared to the S&P 500 index so far this year.

The best solution: Ensure your domestic choices are indeed the best available by doing more research on international investments and alternative asset classes.

AVAILABILITY BIAS

Availability bias is the tendency to estimate the probabilities of future events based on how easily a past event can be recalled. Advertisers have known this for years, but it can have the same effect on investors that it has on consumers.

An investor who suffers from availability bias will be more likely to pursue an investment that has been heavily advertised and more popular in the news simply because they can recall it more easily. There are probably plenty of investors in Research In Motion Ltd. or Apple Corp. these days simply because both companies are in the media nearly every day.

What makes this bias worse is that individual memories are often incomplete, leading investors to recall an investment opportunity for the wrong reason.

Thorough planning is a simple way to mitigate this bias. Construct a long-term plan for your portfolio, detailing how and why your assets will be allocated and diversified. Also make sure to keep detailed records of why specific purchases are made, including both the pros and cons of each investment choice.

Such an approach should eliminate the temptation to invest in a product merely because it can be easily recalled.

LOSS-AVERSION BIAS

Investors who suffer from loss aversion bias focus on investment gains/losses rather than their risk/return combinations. It's a subtle difference, but one that can have major ramifications. Many investors psychologically cannot accept the loss they have incurred and make sub-optimal decisions to avoid realizing the loss.

For example, investors who bought into Nortel at its peak would have witnessed a sharp decline in their shares' value, along with red flags that screamed "Sell." Investors exhibiting loss-aversion bias would see the red flags, yet avoid selling because they are convinced the stock will rebound.

This bias is similar to confirmation bias because it causes investors to ignore negative information. But it may also lead to an unnecessarily risky portfolio.

Distraught Nortel investors in the example above may take on another risky position to make up for their original loss in value from Nortel. As a result, the investor unnecessarily holds two risky positions that probably do not fit their investment needs.

At this point, Mainelli notes the smartest thing to do is to re-evaluate your position and your asset allocation. Try to figure out whether this has been a temporary decline, or whether the company's rapidly deteriorating fundamentals are just the tip of the iceberg