More Cognitive Biases That Cost You Money
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Last week we looked at four "stinking thinking" cognitive biases that contribute to poor investment decisions. Here are six more.
- Monte Carlo fallacy. This is placing too much emphasis on the likelihood of an event happening, just because it hasn’t happened recently. Think of the last 13 years of rise in the stock market. Many investors started betting that stocks would crash after rising for four, five, 10, or 12 years. Yet that history is statistically meaningless. The odds of a market going up or down every year are about the same, regardless of what has happened in previous years.
- Overconfidence. Many people feel they have information or research that is so good, they know what is next. As a professional investment advisor, I experience this occasionally when a client values their "gut feeling" above any empirical data or years of education their investment advisor may offer. One recent example of overconfidence bias was those who "knew" the stock markets would go down immediately if Joe Biden won the 2020 election. Instead, the market had the second highest advance in history.
- Confirmation bias. This is the tendency to only look for data, instances, or research that confirms what we already "know is true." If you were convinced that markets would crash if Joe Biden were elected president, then you would have looked for information supporting that position, and you would find plenty of reinforcement. It would serve us better in such cases to look for information that contradicts our firmly held beliefs. This may help us make more thoughtful and balanced decisions.