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The tendency to seek out information that supports pre-existing beliefs and ignore opposing evidence.
eg/An investor only reads news articles that support her investment decisions and ignores articles that suggest the investment may not be profitable.
Confirmation Bias
Excessive confidence in one’s own abilities leading to taking on too much risk.
eg/A trader makes a high-risk investment without fully understanding the market, believing he can predict the outcome.
Overconfidence
The tendency to feel losses more acutely than gains, resulting in risk-averse behaviour.
eg/ An investor holds a stock too long to avoid selling at a loss, even though its value may continue to fall.
Loss Aversion
Relying too heavily on the first piece of information encountered when making decisions or setting expectations.
eg/ A trader bases her price target for a stock on a recent peak, even though the market has since changed, causing the stock to fall below the target.
Anchoring Bias
The influence of information presented in a certain way on decision making, when the same information presented differently might lead to a different decision.
eg/ An investor is more willing to buy a stock presented as having a 75% success rate than if they were told the same stock had a 25% failure rate
Framing Bias
One’s tendency to believe that they predicted or expected the outcome of an event after it has occurred.
eg/ An investor claims he predicted a market crash after it happened, but he took no steps to mitigate the risk beforehand.
Hindsight Bias
The tendency to follow the actions or beliefs of a larger group rather than making independent decisions
eg/ An investor buys a stock based solely on positive sentiment on social media
Herd Mentality
The tendency to place greater value on immediate rewards and costs rather than future rewards and costs.
eg/ An investor prioritizes short-term gains over long-term returns, even though it isn’t the best decision for the future.
Present Bias
A preference for maintaining the current state of affairs out of comfort with the familiar or fear of change, even when a change may bring a benefit.
eg/ An investor chooses to keep her current investments even though she could meet her financial goals faster if she made changes to her portfolio.
Status Quo Bias
tendency to feel the pain of losses more acutely than the joy of gains
Loss Aversion
Personalized Financial Planning Strategies to mitigate behavioural biases
Create a detailed financial plan that outlines specific goals and objectives, along with the steps needed to achieve them. Such a plan can help clients stay focused on their long-term objectives and avoid making impulsive decisions based on short-term market fluctuations.
Use dollar-cost averaging to invest in the market over time, rather than trying to time the market or make large lump-sum investments. This strategy can help clients avoid the temptation to buy high and sell low, which is a common response to some behavioural biases.
Encourage clients to diversify their investments across different asset classes and sectors, rather than concentrating their investments in a single stock or sector. This strategy can help mitigate the effects of overconfidence bias and prevent excessive risk-taking.
Help clients develop a realistic understanding of their risk tolerance and investment objectives, rather than chasing after high returns or taking on excessive risk. This strategy can help mitigate the effect of biases such as loss aversion and confirmation bias.
Satisfying and sufficing together is a decision making strategy in which people seek out solutions that may not be perfect but are good enough to meet their needs or goals. Most often used in situations where time and information are limited.
Satisficing
This is the tendency to rely on readily available information or examples that come to mind quickly rather than seeking out more complete or accurate information. For example, a person decides to invest in a tech stock because they’ve been hearing a lot about successful tech startups in the news recently, even though the broader market may not support that decision.
Availability Heuristic
Mental Shortcuts - rules of thumb we rely on when we need to make decisions on the fly.
Heuristics
This is the tendency to make decisions based on how closely an option matches a prototype or stereotype rather than considering more objective or statistical information. For example, an investor believes that a particular company’s stock is a good buy because the CEO seems confident and competent, even though the company’s financials may not be strong.
Representativeness Heuristic
This is the tendency to make estimates or judgments by starting with an initial value (the “anchor”) and then adjusting it up or down based on subsequent information. For example, an investor sees that a stock they are interested in has dropped by 20% in the past month, so they assume it is now undervalued and buy more shares without considering whether the stock is actually a good investment at its current price.
Anchoring & Adjustment Heuristic
This is the tendency to decide based on an emotional response rather than a careful consideration of the facts. In other words, people tend to rely on their feelings to make judgments and not on rational thinking. For example, if someone loves the look of a car and the image it represents, they are more likely to buy it, even if it is more expensive or less reliable than other brands.
Affect Heuristic
This is the tendency to base decisions on familiarity rather than objective facts. In other words, people tend to assume that things that are familiar to them are better or more important than things that are less familiar. For example, if someone is trying to choose between two brands of soda, and they recognize one brand but not the other, they are more likely to choose the brand they recognize, even if they have no information about the quality or taste of the unfamiliar brand.
Recognition Heuristic
Strategies to Avoid Mental Shortcuts
-Slow down and think critically; take the time to carefully evaluate the information available, and don’t rush to conclusions. Analyze the evidence, consider alternative viewpoints, and weigh the pros and cons before making a decision.
-Seek out diverse perspectives by surrounding yourself with people who have different backgrounds, experience, and opinions. Engage in thoughtful discussions and debates to challenge your assumptions and broaden your understanding of the issues at hand.
-Use decision-making frameworks such as a cost-benefit analysis to help you organize your thoughts and approach problems systematically.
-Seek out feedback from trusted colleagues and mentors to help you identify blind spots in your thinking and decision-making processes.
-Stay up to date on the latest research and trends in your field and engage in ongoing education and professional development to improve your knowledge and skills.
Intuitive: Our thought processes operate automatically, often without us being aware of it.
Emotional: Our gut reactions and immediate feelings are usually products of System 1.
Effortless: Think of it as your brain on autopilot. It’s how you instantly know two plus two equals four or recognize the face of a friend in a crowd.
System 1 Thinking (Fast)
Analytical: System 2 processes are deliberate and logical, requiring conscious thought.
Rational: The brain weighs options, evaluates risks, and considers evidence before making a decision.
Effortful: It demands a conscious effort to make complex calculations, think critically, or plan for the future.
System 2 Thinking (Slow)
This phase, where informed investors begin to buy assets, is often unrecognized by the general public. It follows a downturn during which pessimism prevails and prices are low. Investors who recognize the undervalued state of assets capitalize on their knowledge, paving the way for the next phase. At this point, there is minimal media attention, and the broader sentiment remains negative or neutral.
accumulation phase
As more investors recognize the upswing in value and start buying, the market begins its upward trajectory. Optimism grows, media coverage becomes positive, and more people jump onto the investing bandwagon. This phase is characterized by rising prices, increased trading volumes, and a general sense of optimism. Investors feel confident, and there is a shared belief that the market will continue to rise.
Uptrend or Bull Market
After a prolonged uptrend, the market starts to plateau. Assets are now considered overvalued and are sold off by the early investors who accumulated them at lower prices. The broader public may still be largely optimistic, making it an opportune time for informed investors to sell. Media might still be positive, but there is a growing divide in opinions about the future market direction.
Distribution Phase
