Behavioral Finance 101
Overreaction Effect and Availability Bias
Status Quo Bias
Behavioral Finance 101As humans, we tend to fall victim to different biases when making financial decisions. Let's take a look at behavioral finance and explore how we can circumvent these common pitfalls.
Gambler's FallacyGambler’s Fallacy is our misunderstanding that random past events can have an effect on future events. A single coin toss always has a 50/50 chance of landing on heads – even if there have been a series of 10 tails tossed just before.
Herd BehaviorHerd Behavior is the tendency for individuals to copy the actions of a larger group. Individually, however, most people would not necessarily make the same choice.
Mental AccountingMental Accounting is when we assign our money into “pots” depending on where it came from and what we are going to spend it on, we may have a holiday pot or bonus money pot whilst having a large credit card debt.
Anchoring BiasAnchoring is the tendency to become attached to a single piece of information that may not be accurate or relevant in trying to draw an appropriate conclusion.
Overreaction Effect and Availability BiasOverreaction is an emotional response to news about a security that is generally led either by greed or fear and pushes the price artificially high or low. Thus, the price does not reflect its fair value.
Overconfidence BiasOverconfidence is the tendency to have an exaggerated belief in our own abilities.
Prospect TheoryProspect Theory deals with the irrational way we process information, valuing gains and losses differently (with losses having a more profound effect on our happiness than gains) and the subsequent decisions we take.
Status Quo BiasStatus quo bias is an emotional bias; a preference for the current state of affairs. The current baseline (or status quo) is taken as a reference point, and any change from that baseline is perceived as a loss.
Confirmation BiasConfirmation Bias is our tendency to try and find information that supports an initial thought or perception we have. We tend not to go after information that may challenge the idea.
Anchoring BiasIn this video, the cognitive scientist Laurie Santos (Yale University) explains the phenomenon of anchoring. She shows how arbitrary information sometimes can sometimes act as an anchor that affects our judgments in unexpected ways.
Self-Serving BiasA self-serving bias is any cognitive or perceptual process that is distorted by the need to maintain and enhance self esteem. When individuals reject the validity of negative feedback, focus on their strengths and achievements but overlook their faults and failures, or take more responsibility for their group's work than they give to other members, they are protecting the ego from threat and injury. These cognitive and perceptual tendencies perpetuate illusions and error, but they also serve the self's need for esteem.