FIS Evidence-Based Investment Insights: Behavioral Biases – What Makes Your Brain Trick?
January 23, 2015 | By fischer |
Welcome to the next installment in our series of FIS’s Evidence-Based Investment Insights: Behavioral Biases – What Makes Your Brain Tick?
In our last piece, “The Human Factor in Evidence-Based Investing” we explored how our deep-seated “fight or flight” instincts generate an array of behavioral biases that trick us into making significant money-management mistakes. In this installment, we’ll familiarize you with a half-dozen of these more potent biases, and how you can avoid sabotaging your own best-laid, investment plans by recognizing the signs of a behavioral booby trap.
Behavioral Bias #1: Herd Mentality
Herd mentality is what happens to you when you see a market movement afoot and you conclude that you had best join the stampede. The herd may be hurtling toward what seems like a hot buying opportunity, such as a run on a stock or stock market sector. Or it may be fleeing a widely perceived risk, such as a country in economic turmoil. Either way, as we covered in “Ignoring the Siren Song of Daily Market Pricing,” following the herd puts you on a dangerous path toward buying high, selling low and incurring unnecessary expenses en route.
Behavioral Bias #2: Recency
Even without a herd to speed your way, your long-term plans are at risk when you succumb to the tendency to give recent information greater weight than the long-term evidence warrants. From our earlier piece, “What Drives Market Returns?” we know that stocks have historically delivered premium returns over bonds. And yet, whenever stock markets dip downward, we typically see recency at play, as droves of investors sell their stocks to seek “safe harbor” (or vice-versa when bull markets on a tear).
Behavioral Bias #3: Confirmation Bias
Confirmation bias is the tendency to favor evidence that supports our beliefs and gloss over that which refutes it. We’ll notice and watch news s