Behavioral Biases Flashcards
Cognitive error
biases influenced by faulty reasoning, result from errors in processing and retaining information
Emotional biases
biases influenced by emotions or feelings
conservatism
maintain prior view by inadequately incorporating new conflicting information (overweight prior info and underweight new info)
confirmation bias
look for and notice what confirms your beliefs and ignore or undervalue what contradicts beliefs
Consequence
* consider only positive information and ignore negative info,
* develop - screening criteria and ignore info that refutes the validity of the critera
* underdiversify portfolios
* hold a disproportionate share of assets in a company’s stock
Guidance
* actively seek out info that challenges existing belief
* get corroborating support
illusion of control bias
people tend to believe they can control or influence outcomes when in fact thet cannot
Consequence
inadequately diversify portfolios
trade more than is prudent
construct financial models and forecasts that are overly detailed
Guidance
* * Focus on long-term investments that are not impacted by short-term
emotions and beliefs.
* * seek contrary viewpoints
hindsight bias
seeing past events as having been predictable and reasonable to expect
tend to rememeber our own predictions as having been more accurate
Consequence
overestimate the degree to which a preducation was accurate
unfairly assess th performance of others
Guidance
keep a log, understand why investment did/didn’t work
anchoring and adjustment bias
when required to estimate a value with unknown magniture, people generally begin by envisioning some initial default number which they adjust up/down to reflect subsequent information and analysis
Consequence
stick to closely to original estimates of value
hold investments too long or sell too early
Guidance
awareness, periodically review decision-making process, focus on company’s fundamental rather than price target
framing bias
definition a person responds differently bases on how a problem is framed
Consequence
misidentify risk tolerances - become more risk averse when presented with a gain and more risk-seeking when presented with a loss frame
Guidance
reframe the problem, focus on future expectations
availaility bias
estimate prob based on how easily something comes to mind, easily recalled outcomes are perceived as more likely
retrievability
an answer that comes to mind more quickly will likely be chosen as correct
categorization
if you can’t name an instance you may conclude it’s small
loss-aversion
people tend to strongly prefer avoiding losses as opposed to achieving gains
Consequence
hold investments in a loss position longer than justified in the hope that they’ll return to break-even or better
sell investments in gain positions out of fear
overconfidence
people demonstrate unwarranted faith in their own abilities, reasoning and judgement
Consequence
underestimate risk and overstimate expected returns
hold poorly diversified portfolios
Guidance
keep a record of all trades/outcomes
conduct post-investment analysis on both winners and losers
self-control
people fail to act in pursuit of their LT
Consequence
save insufficiently for the future which may result in accepting too much risk in portfolios in an attempt to generate return, asset allocation imbalance problems
Guidance
proper investment plan + personal budget
maintain an optimized strategic asset allocation
status-quo
people choose to do nothing instead of making a change even when change is warranted
Consequence
unknowingly maintain portfolios with inappropriate risk characteristics
fail to explore other opportunities
Guidance
education
