{"id":8476,"date":"2020-01-14T00:01:14","date_gmt":"2020-01-14T05:01:14","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=8476"},"modified":"2020-06-06T02:44:22","modified_gmt":"2020-06-06T06:44:22","slug":"the-major-behavioral-biases-influencing-your-investment-decisions","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2020\/01\/14\/the-major-behavioral-biases-influencing-your-investment-decisions\/","title":{"rendered":"The Major Behavioral Biases Influencing Your Investment Decisions"},"content":{"rendered":"

Jason Voss recently spoke at the 2019 AAII Investor Conference. If you weren’t able to attend, session audio and handouts are available for purchase at:<\/strong><\/em><\/span><\/p>\n

www.aaii.com\/investoraudio<\/a>.<\/strong><\/em><\/span><\/p>\n

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Recognizing the major biases is the first step in learning how to avoid them in your investing.<\/span><\/strong><\/span><\/p>\n

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You may not believe it, but science has proven that you and I are biased and often make irrational decisions. Here is the evidence.<\/span><\/p>\n

Imagine a game pays $1.10 if a fair coin comes up heads and costs $1 if it comes up tails. You can participate in this game as often as you wish, as long as you hold up a dollar prior to each flip to ensure you are good for the potential loss.<\/span><\/p>\n

Would you participate? For how many rounds? In answering this question, it might help to know that the expected return on each round is $0.05, or 5%, of your one dollar \u201cinvestment.\u201d (The math is $0.05 = [(0.5 \u00d7 $1.10) + (0.5 \u00d7 $1.00) \u2013 $1.00]). Does this change your decision regarding whether to participate?<\/span><\/p>\n

Of course, you should play this game forever, as the expected return in each round is $0.05 and you will become hugely wealthy over time. But it turns out that very few of us would participate. This is because most of us experience far greater pain from losing one dollar than the joy we get from winning $1.10. What is more, the fact that the game can be played multiple times seems to have a limited impact on the decision. It appears we view each round as a separate event. This particular decision-making bias is known as \u201closs aversion,\u201d and I discuss it more fully in the next section.<\/span><\/p>\n

This result stands in stark contrast to that imagined by classic economists, who assume that all of us make perfectly rational decisions. Chances are that had any of the formulators of economic theory done a check with anyone other than the robotic folks who advanced their theory, those formulators would have known what we know. Namely, that all of us frequently make irrational decisions.<\/span><\/p>\n

That we are all biased is interesting. But even more interesting is the question of how do we avoid these biases to become better investors?<\/span><\/p>\n

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The LOC HAARM Biases<\/span><\/strong><\/span><\/p>\n

Philosophers have, of course, noted bias in people\u2019s thinking for thousands of years, but scientists in psychology only began formally researching bias in human decision-making in the 20th century. Since then well over a hundred different behavioral biases affecting decision-making have been identified, as documented on The Psy-Fi Blog and Wikipedia.<\/span><\/p>\n

Of the formally identified biases, there are less than 10 that deserve the attention of investors. It isn\u2019t that the others are unimportant, it is just that many of them are corollaries of these major biases:<\/span><\/p>\n