Common bias's to be aware of

Confirmation bias

This occurs when we only look for and react to information so that it reconfirms our original views. This happens a lot in every day life, we talk to people with the same views, watch interviews conveying one particular side of an argument etc. 

 

We are prone to dismissing others who oppose our views, because our individual point of view become part of our identity; we oppose others as its contrasting our own identity. Sometimes we may be basing our decisions/views on emotions and not logic; and dismiss the logical facts because we are don't want our identity challenged. This is detrimental to being a successful investor. 

To overcome this, we need to emotionally detach from our investments and viewpoints. Be ready to admit that your idea is wrong, or that you missed something. Don’t put pride in front of rational thought. We all get it wrong, the best investors are the ones who can accept that, and move on.

 

Short term bias

See NBS’s feature on short termism in finance.

We get influenced by constant news, daily predictions & scary headlines that cause us to make decisions based on fear & emotion.

To overcome this we need to step away from the news, and see it for what it is; its daily noise that journalists must produce to justify their existence. What was the front page headline this time last week? On the day it seemed important, yet now its pointless noise.

Being exposed to constant news and noise is bad for your mental health. Step away from it, appreciate that good things take time. Think of your investment as a seed, step back and let it grow into a magnificent tree. You don’t need to check on it every day, there’s no point. Only if it starts dying, then we pay attention to it.

 

Loss aversion

Human beings strongly prefer avoiding loss as opposed to making gains.

 

Endowment effect

This occurs when we place higher values on goods we own, than we do to identical goods we do not own. We get emotionally attached to things we own, and subconsciously value them higher then their true worth.

If you have a handful of stocks, you will likely form an emotional connection to them, considering them to be better value than they are.

We must sever all emotional ties to our investments, and look at them objectively. It doesn’t matter how much you love a particular company and have held shares in it for a long time; you must be ready to sever ties to it if the long term investment thesis is broken.

 

Hindsight bias

Hindsight is wonderful thing. When you look back to the past with hindsight, it can seem so obvious that the events played out the way they did.

An example, how influential is the internet in our every day lives? Looking back it seems that It was just an invention waiting to happen. Yet the inventor of the internet, famously said he didn’t believe that there was any need for a few more than a dozen computers across the globe.

We overcome this hindsight by writing out our detailed thesis at the time of investing. By doing so, we can look back objectively and know that we made the right call at the time.

 

Bandwagon effect

Otherwise known as herd mentality, we gain comfort in following the crowd, and in group think. It’s hard and uncomfortable to hold contrarian views.

Herd mentality is the NO.1 enemy to being a successful investor. Speculative bubbles happen all the time, and it’s because of herd mentality.

To overcome this, we need step back from what everyone is saying, and objectively analyse the facts. The herd is a crazy thing, look at the recent crypto bubble. That was sheer madness, yet everyone started to believe in it for a second, dinner parties across the globe were rife with talk about cryptos.

If you stood back and looked objectively, you could see so clearly that cryptocurrencies are utter garbage, with no real value at all. Group think can do make rational human beings make amazingly stupid decisions. 

Isacc Newton famously said "I can calculate the movement of stars, but not the madness of men", after he lost his life savings in the 'South Sea Bubble' in the 1700's. 

 

Anchoring bias

This occurs when we rely too heavily on a past reference point.

Think of Telstra, we look back at their share price and say wow, it was once at $6, and now is at $3, so therefore it must be a cheap investment.

However when we look at this objectively, we can see that the business is fundamentally different now then it was in the past.

Where things have been in the past often gives us zero indication of what is true now. We must always look at the facts of today, and not let our decision making be influenced by past reference points.

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