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The ABCs of Behavioral Bias: Part One

February 28, 2018 View all posts by Atlas Wealth Advisors Atlas Wealth Advisors Behavior Bias, Investing

Welcome to your first installment of the “ABCs of Behavioral Biases.” Let’s start by looking at four self-inflicted biases: anchoring, blind spot, confirmation, and familiarity bias.

ANCHORING BIAS

What is it?

Fixing decisions on a point of reference (“anchor”), valid or not, can be the beginning of anchoring bias.

When is it helpful?

When the anchor is chosen wisely, it can contribute to healthier decisions that will help keep you on track to achieving your goals. If you made a new year’s resolution to live a healthier lifestyle, choosing to “anchor” yourself to an exercise routine will help increase your chances of achieving your specific health goals.

When is it harmful?

“I paid ten dollars per share and now it’s only worth eight. I’ll hold onto it until I at least break even.”

“Last year this stock was worth twice what it is now. I’ll wait until it goes back up to sell.”

This is the anchoring bias at work in a way that could be harmful to your long-term financial goals because it does not take the entirety of your financial situation into account, much less consider what’s the opportunity cost of this decision. Anchoring to the performance of one investment in your portfolio can lead you to overlook the impact that has on your entire portfolio and your financial goals.

At Atlas, we’ll help you look at the impact of the anchoring biases you may be hanging on to when it comes to your portfolio. We’ll address every detail of your investments in a comprehensive and custom plan tailored to help you accomplish your financial goals and chart your progress to help you make better financial decisions.

BLIND SPOT BIAS

What is it?

Our blind spots are right next to the proverbial plank in our own eye. Our blind spot is at work when we can easily spot the biases of others, but somehow fail to recognize our own.

When is it helpful?

At one time or another, we’ve all most likely wrestled with analysis paralysis. If we scrutinized every move we made, we would never do anything. Life must be lived, and blind spots can keep us moving, even when doubts may still be present.

When is it harmful?

Cultivating awareness can help us see biases at work and minimize them in our own lives, but blind spots will always exist. In Thinking, Fast and Slow, Nobel laureate Daniel Kahneman writes: “We are often confident even when we are wrong, and an objective observer is more likely to detect our errors than we are.” Enlisting the help of a consultant, advisor, or guide can be eye-opening.

CONFIRMATION BIAS

What is it?

It’s amazing how quickly we can rack up evidence behind a foregone conclusion! We tend to favor the facts that confirm what we already believe and be blind to those that don’t.

When is it helpful?

Decisions, especially those that must be made quickly, usually rely on past experience. What worked in previous situations can often be a more reliable route than making decisions without considering our experience.

When is it harmful?

Beliefs hold on like wisdom teeth – they are rooted deep and nearly impossible to remove without the right tools. Confirmation bias can cause us to ignore conflicting evidence and focus only on that which supports our position, often seeing coincidence as proof and making snap decisions. Even stock analysts aren’t above this bias.

FAMILIARITY BIAS

What is it?

We gravitate toward the familiar, whether as a baby with our parents or a team on our home field. The same is true in finance – we go with what we know, even if it’s not the best.

When is it helpful?

Familiarity bias, when implemented correctly, could also be called “loyalty.” You make use of familiarity bias every time you cheer for your home team, use your favorite pillow, or hire based on a recommendation from a trusted colleague.

When is it harmful?

A great tool for managing risk is a globally diversified portfolio, yet studies show that investors favor familiar over foreign investments. Our instincts can betray us by keeping us from applying the principles of diversification to our portfolios.* Again, bringing in a third party can help you protect yourself from this bias.

Want to learn more? Come back next time when we continue our series on the ABCs of Behavioral Biases.

 

 Click here to get clear, actionable counsel. 

 

Read The Previous Article in this Series:

How to Know Yourself as an Investor: Behavioral Bias in Finance

 

 

*Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.

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