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Behavioral Biases – The Demon of Investing

An advisor’s job is just as much about helping clients control their investing bias and emotions as it is about building and managing an appropriate portfolio.  Here are five traits we see:

Which way to go road sign Anchoring Bias – It occurs when you fix on or “anchor” your decisions to a reference point, whether or not it’s a valid one.

Confirmation Bias – We humans love to be right and hate to be wrong.  It tricks us into being extra sympathetic to information that supports our beliefs and especially suspicious of – or even entirely blind to – conflicting evidence.

Familiarity Bias – It’s a mental shortcut investors use to more quickly trust an object that is familiar to us.  Investors are quicker to invest in familiar US holdings versus unfamiliar foreign investments.

Framing Bias – Nobel laureate Daniel Kahneman defines the effects of framing as follows:  “Different ways of presenting the same information often evoke different emotions.” For example, he explains how consumers tend to prefer cold cuts labeled “90% fat-free” over those labeled “10% fat.”  By narrowly framing the information (fat-free = good, fat = bad; never mind the rest), we fail to consider all the facts as a whole.

Herd Mentality – Mooove over, cows.  You’ve got nothing on us humans, who instinctively recoil or rush headlong into excitement when we see others doing the same. “The idea that people conform to the behavior of others is among the most accepted principles of psychology,” write Gary Belsky and Thomas Gilovich in “Why Smart People Make Big Money Mistakes.”

 

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