Thursday, November 15 2012
In my weekly scan of the internet I came across a really interesting summary of Investors’ 10 Most Common Behavioral Biases.
The article was a summary of a piece published in the Washington Post by Barry Ritholz, a columnist for the paper.
The importance of having an awareness and knowledge of these biases is to help protect yourself from making poor decisions that you will live to regret. In a nutshell they include:
Confirmation Bias – the act of coming to a conclusion first and then looking for evidence to support that conclusion.
Optimism Bias – having over confidence in our own judgment above the judgment of others.
Loss Aversion – losses hurt more than the joy of the same amount of gains.
Self-Serving Bias – the good that happens is our doing, when things go against us it is the fault of someone else.
The Planning Fallacy – the tendency to underestimate the time, costs, and risks of future actions but at the same time overestimate the benefits.
Choice Paralysis – too many choices lead us to doing nothing.
Herding – the tendency to follow others.
We Prefer Stories to Analysis – including the tendency to look backwards and create patterns to fit events and then constructing a story that explains what happened along with what caused it to happen.
Recency Bias – the tendency to extrapolate recent events into the future indefinitely.
The Bias Blind-Spot – the tendency not to take into account these biases when making decisions.
(NB - The link to the original article provides more in depth discussion of each bias along with links to further details.)
We can either trust ourselves to take into account these behavioural biases before making financial (including investment) decisions or we can look to professional help from financial advisers, accountants etc to provide a sounding board.
A good adviser can talk through the pros and cons from hopefully an unbiased viewpoint. This might mean you still go through with your plan but it will have been put through and benefitted from a rigorous analysis along the way.
The decisions financial advisers counsel against making are often (if not more) important than the proactive advice they provide.