Knowing our biases can help us become better investors. So what are yours?
Confirmation bias
The confirmation bias refers to the phenomenon of seeking selective information to support one’s own opinions or to interpret the facts in a way that suits our own world view. Investors seek confirmation for their assumptions. They avoid critical opinions and reports, reading only those articles that put the point of view in a positive light.
Availability/Attention bias
The attention bias states that things such as products, companies, and issuers that are more frequently present in the media will be remembered more quickly by investors when they look for a suitable investment instrument.
Bad or scarcely accessible information is (unconsciously) not considered.
Home bias
Statistics show that most investors tend to buy stocks from companies in their home country. These stocks seem more trustworthy, and investors grew up with these company names. They are also mentioned more frequently in the local media.
Favorite long-short bias
People who fall into this psychological trap always bet on the long shot, because it promises very high returns. Unfortunately, they forget that the likelihood of the long shot winning cancels out the profit in the middle.
Anchoring
When making decisions, investors do not rely on fundamental factors. Rather, they tend to base their decision on the price at which the original or last position in a stock was purchased. This purchase price is the anchor and causes irrational decisions. Unlike the acquisition cost, the new price seems cheap to the investor. Anchoring influences individual decisions based on the fact that investors do not realize how the information is presented. When it comes to making decisions, people seem to be influenced by random data, even if they know that the data has no informational value or is outrageously high or low.
Myopic loss aversion
Most investors fear losses more than they enjoy profits. If these investors look at their stock performance too often, they usually see they have lost money and sell everything off again. A long-term view would be better. They should check their stock performance less often. The more they can keep their curiosity at bay, the more likely they are to turn a profit with their investments, provided that the portfolio is broadly diversified.
Mental accounting
Many private investors engage in mental accounting, i.e., they make distinctions in their head that do not exist financially. Often, losses incurred are viewed separately from paper losses. This means that people sell stocks from their portfolio too soon when they make a profit and too late when they make a loss. So mental accounting makes us think that
a franc is not worth a franc – a dangerous attitude.
Disposition effect
Gains are realized too early and losses too late as a result. Turning a paper profit into real profits makes us happy, while we shy away from turning a paper loss into a real loss. One possible explanation is mental accounting (see above).
Overconfidence
In most cases, we overestimate our own abilities and think we are above average. Notably, most experts also overestimate themselves – frequently to a greater degree than laypersons do. Overconfidence is often seen when the markets are on the rise.
Hindsight bias
The statement “I knew the whole time this would happen” shows that hindsight is 20/20 and that we have an explanation for everything after the fact. This is known as the hindsight bias, which is a problem because it keeps us from learning from our mistakes.
Get-even-itis
Once we have lost money we take a greater risk to make up for it. Get-even-itis can cause us to place everything in one basket and probably lose even more money.
Representativeness bias
After even a brief period of positive returns on the financial markets, we may think the world has changed for the better. People tend to think in schemes and stereotypes learned in the past. They arrive at a result too quickly and based on imprecise information.
Gambler’s fallacy
Here, the effective probabilities are greatly underestimated or overestimated. This can mean that, based on the (false) assumption that prices are about to drop, we sell too soon and vice versa (assumption that the prices will recover soon, even though they are not (yet) doing so).
Framing bias
Decisions are based largely on how facts are depicted in statistical terms. For instance, we do not think that “Four out of ten are winners” and “Six out of ten are losers” mean the same thing. The statement is identical, but most people don’t realize it.
Regret avoidance
If we invest in a blue chip stock and it does not perform as hoped, we call this bad luck. However, if we invest in a niche product that fails to perform well, we tend to regret this more than we do the failure of the blue chip stock. This is because many other people have made the same mistake and thus our decision to buy it does not seem so wrong.
Another bias - favorite of mine - that was not listed so far is the inability of the brain to grasp exponential growth (also called Weber’s law).
Would you prefer that I give you:
-a) 700k CHF now, or
-b) 1 Rappen doubled every day for 30 days
The way the question is framed, our brain is incapable of figuring out that proposition b) is one order of magnitude bigger than proposition a). It is worth a bit more than CHF 10 million, by the way). This has far-reaching consequences in the tendency of market participants to systematically under-rate the value of long term profitable compounders…
Reviving this conversation: Now that I’ve spent all my dry powder on VT, there’s nothing left for me to do but wait for compounding to kick in.
It goes against my nature to just not do anything, that’s why there’s a huge risk for me to fall for some particular bet (or “tilt”, how the financial industry would call it more alluringly).
And even worse: The risk of losing precious time of my life on over-researching stuff.
Good thing is that you spend all your money now, so you can relax. Go out in nature, spend time with your loved ones, have a beer with friends.
There are so many more important topics than money. Also, don’t worry about the current drop - you are investing for long-term. That’s why a lot of the stuff we discuss in this forum is not worth spending so much time and energy on.
I’m never gonna worry about a drop, because I’m in this game for the long run
It’s just been so much embedded in me that all success comes from putting hard effort and labor into stuff, but the concept of passive investing and waiting for the compounding effect goes so contrary to this Actually, the more you do, the more you lose.
So I totally agree, I’m ginna go out to enjoy the nice weather
Same here, same here. I saw an anecdotal statement that some of the millionaires in US that you would never think they are, were averagely earning office worker ladies who didn’t do anything else but to dump all their excess cash into S&P500 index funds - for 40-50 years.
Going back to the original question: do something else. A work towards carrier advance is also a great investment. Or anything else, or nothing in particular.
If you have the urge to gamble, then you can still allow yourself for example a 5% gamble portfolio. If you make some extra money then thats perfect, and otherwise its a good reminder, why you have those 95% in (a) passive etf(s)
I’m “the worst” when it comes to this, but if the quest for an always better financial situation is a driver for this, a solution could be focusing on increasing your contributions by furthering your career or launching a side hustle.
If it’s the fiddling with spreadsheets/other tools and looking at numbers/graphs part that takes your interest, fiddling with other data might do it (expenses tracking, categorizing and optimizing looks to me like an ideal victim).
If it’s neither of those, focusing on other aspects of life while reveling in the fact that my financial life is in order and I don’t have to worry about it anymore, as suggested before, would be my best bet.
The concept of the “behavior gap” is a significant issue in the world of investing. Carl explained that the behavior gap represents the difference between the returns an investment could achieve and the actual returns investors experience due to poor decisions based on emotions and behavior. While an investment may promise a certain percentage return if left untouched for a decade, most investors in reality don’t behave in a way that allows them to realize that return.
Will second that again and again :
Good investing flies in the face of what we are taught in nearly every other part of our lives. In most parts of life, the harder you work and the more energy you put into something, the better the return will be. Investing is one of the rare places that you are rewarded for doing less. And that can be hard for us to remember.
My bias is mainly related to two countries I feel I am part of.
Overweight -: CH & IN
This automatically makes me underweight USA. I anyways feel a bit concerned about so much of my investments tied to one country but since it’s the biggest market, I need to live with it.
1-3. Not at all
4. Maybe
5-7. Nope
8. Possibly but combined with 4 I avoid realizing gains
9. Nope
10. Perhaps
11-12. Nope
13. Maybe
14. Yes, on the name, no on the text. I want to minimize regret!
Charlie Munger’s transcript needs coffee and cigarettes and the family being in bed to read properly, looks like gold.
I’m printing this, each page followed by a blank one for notes. Do you have more of this type of content?
Funny how Charlie is smoother in his roasting of people in this talk.
You probably want to read Poor Charlie’s Almanack, which is a collection of all the important talks that Charlie ever gave.
Stripe Press did a new edition recently, but if you don’t want a physical copy all the chapters are available online for free courtesy of Stripe.
3 Likes
By reading and partipating to this forum, you confirm you have read and agree with the disclaimer presented on http://www.mustachianpost.com/
En lisant et participant à ce forum, tu confirmes avoir lu et être d'accord avec l'avis de dégagement de responsabilité présenté sur http://www.mustachianpost.com/fr/
Durch das Lesen und die Teilnahme an diesem Forum bestätigst du, dass du den auf http://www.mustachianpost.com/de/ dargestellten Haftungsausschluss gelesen hast und damit einverstanden bist.
Actually, the more you do, the more you lose.
: