The trouble with life is that it’s pretty damn difficult. So in order to cope, our brains formulate hundreds of little delusions – and while said delusions might make us feel better, they’re the same ones that sometimes whisper at us to eat our neighbour’s left ear, or to invest all our life savings in a surf shop in Afghanistan:
1. The Self-Serving Bias
This is the tendency to attribute our success to personal qualities.
For example, highly paid individuals like to think their income is based on their personal worth, and not so much because dad could pay for their Ivy league college degree.
Self serving bias also means we prefer to blame failure on bad luck, or forces beyond our control. Just listen to a bunch of lousy sales people – there’s usually a million reasons why they can’t close a deal, and approximately zero of those reasons are “I suck at selling things”.
Self-serving bias leads to investment chaos when it gets out of hand. This sometimes happens when we make a few good investments, and the returns pour in. Suddenly, we feel like we could give Warren Buffet a few stock tips.
Everything we’ve bought has paid off, so we know what we’re doing. And we’ll do it, even if the past few successes were dumb luck, and our financial advisor is looking at our decisions with a face that’s whiter than Mahjong paper.
And when we’re in the grip of investment bias, we attribute any losses to luck. Our “perfect” investment strategy was set back by a freak event, and if we just keep plugging on, it will work out fine.
In short, self serving bias encourages us to stick to flawed investment plans; because our self-esteem is too fragile to admit we’re wrong. The only way out is seems to be the classic virtue of humility: always bear in mind that your past successes could be due to luck, not skill.
Tattoo that last line on your forearm if you have to. It will stop you from persisting in many a stupid decision.
Think of your brain as a fast car with very bad steering. Once a direction has been picked, it’s hard to change direction, much less reverse.
This is a serious problem when it comes to financial forecasts. Once a newspaper, TV channel, or even this blog makes a prediction, the audience tends to cling to it. Even when new information comes along.
For example, say someone tells you his gold trading company will earn you millions. He shows you a zillion charts, which are all halfway plausible. And he tells you that, hey, there’s a 30 day cooling off period. You can change your mind later, so no problem.
The very next day, you read about a gold trading scam. A week later, a cousin tells you how he got ripped off by a gold trader. Two weeks later, you ask your fortune teller about it, and his cards catch fire while he tries to work it out. You get the idea: everything suggests its a bad deal.
Even then chances are high that you won’t back out. If you’re like many investors, especially new ones, you’ll find it hard to change your mind once you’ve made a decision. And even if you do react, you’re likely to invest less, not pull out altogether.
So here’s another phrase to paste all over desktop: only a fool never changes her mind. Try to avoid an irrational need to stay consistent with a former decision, even in the light of new data.
3. Representativeness Bias
This is where stereotyping comes from (e.g. one property agent I know is rich, therefore all property agents are rich). This is a kind of mental shortcut (a heuristic) that your mind uses when its too lazy to process reels of information.
It explains why new investors can be convinced through tiny, almost irrelevant samples of an investment product’s returns. For example, say someone with no investment knowledge watches TV, and sees an interview with an active trader who makes $1 million overnight.
There’s a high chance the links made in his mind are:
- That one investment made high returns overnight, so all stock investments must make high returns overnight
- That one trader got rich by doing something on the stock market, so everyone who gets involved in the stock market will get rich
How often have you made an investment decision because it turned out well for one friend? Or guessed that property must be an infallible investment because the price went up over a tiny span of five years?
The best way to avoid this bias is to habitually do your homework. Don’t get lazy, and assume the immediate sample in front of you is enough “research”.
Which investor biases do you think you suffer from? Comment and let us know!
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