People in standard finance are rational. People in behavioral finance are normal.

Bias Name: Overconfidence Bias Type: Cognitive

Too many people overvalue what they are not and undervalue what they are. People think they are smarter and have better information than they actually do.

Excessive trading. Underestimating downside risks. Portfolio under diversification.

Bias Name: Representativeness Bias Type: Cognitive

In order to derive meaning from life experiences, people have developed an innate propensity for classifying objects and thoughts. When they confront a new phenomenon that is inconsistent with any of their pre constructed classifications, they subject it to those classifications anyway, relying on a rough best-fit approximation to determine which category should house and, thereafter, form the basis for their understanding of the new element

Investors ignore the statistically dominant result in order to satisfy their need for patterns. Due to the fact that many examples of representativeness bias exist, this advice tries to address how to get rid of it so by looking at true facts and figure and right information. After effect results this bias can be reduced.

Bias Name: Anchoring and Adjustment Bias Type: Cognitive

To reach a port we must sail, sometimes with the wind, and sometimes against it. But we must not drift or lie at anchor. Example: Suppose you are asked whether the population of Canada is greater than or less than 20 million. Obviously, you will answer either above 20 million or below 20 million. If you were then asked to guess an absolute population value, your estimate would probably fall some where near 20 million, because you are likely subject to anchoring by your previous response. Example Investors tend to make a forecast of the percentage that a particular asset class might rise or fall based on the current level of returns. For example, if the DJIA returned 10 percent last year, investors will be anchored on this number when making a forecast about next year.

If a rival negotiator makes a first bid, do not assume that this number closely approximates a potential final price. Awareness is the best countermeasure to anchoring and adjustment bias.

Bias Name: Cognitive Dissonance Bias Type: Cognitive

When newly acquired information conflicts with preexisting understandings, people often experience mental discomfort a psychological phenomenon known as cognitive dissonance. For example, a consumer might purchase a certain brand of lawn mower, initially believing that it is the best lawn mower available. However, when a new cognition that favors a substitute lawn mower is introduced, representing an imbalance, cognitive dissonance then occurs in an attempt to relieve the discomfort with the notion that perhaps the buyer did not purchase the right lawn mower. People will go to great lengths to convince themselves that the lawn mower they actually bought is better than the one they just learned about, to avoid mental discomfort associated with their initial purchase.

1) 2) 3)

Modifying beliefs Modifying actions Modifying perceptions of relevant action(s).

Bias Name: Availability Bias Bias Type: Cognitive

The availability bias is a rule of thumb, or mental shortcut, that allows people to estimate the probability of an outcome based on how prevalent or familiar that outcome appears in their lives. Example: the tendency of most people to guess that shark attacks more frequently cause fatalities than airplane parts falling from the sky do. However, as difficult as it may be to comprehend, the latter is actually 30 times more likely to occur. Shark attacks are probably assumed to be more prevalent because sharks invoke greater fear or because shark attacks receive a disproportionate degree of media attention. Consequently, dying from a shark attack is, for most respondents, easier to imagine than death by falling airplane parts.

In order to overcome availability bias, investors need to carefully research and

contemplate investment decisions before executing them

Bias Name: Self-Attribution Bias Bias Type: Cognitive Self-attribution bias (or self-serving attributional bias) refers to the tendency of individuals to ascribe their successes to innate aspects, such as talent or foresight, while more often blaming failures on outside influences, such as bad luck. Technical Description. Self-attribution is a cognitive phenomenon by which people attribute failures to situational factors and successes to dispositional factors.

When reviewing unprofitable decisions, look for patterns or common mistakes that perhaps you were unaware of making. Note any such tendencies that you discover, and try to remain mindful of them by, for example, brainstorming a rule or a reminder such as: I will not do X in the future or I will do Y in the future. Being conscious of these rules will help you overcome any bad habits that you may have acquired and can also reinforce your reliance on the strategies that have served you well. Remember: Admitting and learning from your past mistakes is the best way to become a smarter, better, and more successful investor!

Bias Name: Illusion of Control Bias Bias Type: Cognitive

claim not to have controlled events, but confess plainly that events have controlled me. Abraham Lincoln

The illusion of control bias describes the tendency of human beings to believe that they can control or at least influence outcomes when, in fact, they cannot.

Recognize that successful investing is a probabilistic activity. Recognize and avoid circumstances that trigger susceptibility illusions of control. 3) Seek contrary viewpoints. 4) Maintain records of your transactions
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Bias Name: Conservatism Bias Bias Type: Cognitive

Conservatism bias is a mental process in which people stick to their prior views or forecasts at the expense of acknowledging new information. For example, suppose that an investor receives some bad news regarding a companys earnings and that this news negatively contradicts another earnings estimate issued the previous month. Conservatism bias may cause the investor to under react to the new information, maintaining impressions derived from the previous estimate rather than acting on the updated information. It is important to note that the conservatism bias may appear to conflict with representativeness bias, in representativeness,
people overreact to new information.

Because conservatism is a cognitive bias, advice and information can often correct or lessen its effect. Specifically, investors must first avoid clinging to forecasts; they must also be sure to react, decisively, to new information. This does not mean that investors should respond to events without careful analysis. However, when the wisest course of action become clear, it should be
implemented resolutely and without hesitation

Bias Name: Ambiguity Aversion Bias Type: Cognitive

People do not like to gamble when probability distributions seem uncertain. In general, people hesitate in situations of ambiguity, a tendency referred to as ambiguity aversion. Hence demand high returns.

There are several key areas of which investors need to be

aware with regard to ambiguity aversion. Awareness: Investors need to be educated on how the relevant asset classes perform and how adding these asset classes to a diversified portfolio can be a beneficial action. Competence: counseled on potential investor mistakes For example, if you have an investor who is an expert in real estate, does that mean that he or she should be 100 percent invested in real estate? The obvious answer is no. Stick to the fundamentals of a balanced, welldiversified portfolio.

Bias Name: Endowment Bias Bias Type: Emotional

Endowment bias is described as a mental process in which a differential weight is placed on the value of an object. People who exhibit endowment bias value an asset more when they hold property rights to it than when they dont. Endowment bias causes investors to hold securities that they have either inherited or purchased because they do not want to incur the transaction costs associated with selling the securities. These costs, however, can be a very small price to pay when evacuating an unwise investment.

Generally, endowment bias tends to decrease by

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Information Awareness

Bias Name: Self-Control Bias Bias Type: Emotional Simply put, self-control bias is a human behavioral tendency that causes people to consume today at the expense of saving for tomorrow. Self-control bias can cause investors to lose sight of basic financial principles, such as compounding of interest, dollar cost averaging, and similar discipline behaviors that, if adhered to, can help create significant long-term wealth.

When a practitioner encounters self-control bias, there are four primary topics on which advice can generally be given:

1) spending control 2) lack of planning 3) portfolio allocation 4) the benefits of discipline.

Bias Name: Optimism Bias Type: Emotional

Most people have heard of rose-colored glasses and know that those who wear them tend to view the world with undue optimism. Optimism bias can cause investors to read too much into rosy forecasts such as earnings estimates of analysts or their own research done by reading show rosy outlooks. Additionally, get good news about the markets or their investments and so may be predisposed to optimism versus pessimism.

company reports that investors prefer to

Fundamentally, there are four main pieces of advice from which investors exhibiting optimism bias might generally benefit.
Live below your means, and save regularly. Asset allocation is the key to a successful portfolio. Compounding contributes significantly to long-term financial success. Encourage the use of a financial advisor.

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3.
4.

Bias Name: Mental Accounting Bias Type: Cognitive

Mental Accounting describes peoples tendency to code, categorize, and evaluate economic outcomes by grouping their assets into any number of non fungible (non interchangeable) mental accounts.

A completely rational person would never succumb to this sort of process because mental accounting causes subjects to take the irrational step of treating various sums of money differently based on where these sums are mentally categorized, for example, the way that a certain sum has been obtained (work, inheritance, gambling, bonus, etc.) or the nature of the moneys intended use (leisure, necessities, etc.). The concept of framing is important in mental accounting analysis.

People mentally allocate wealth over three classifications: (1) current income, (2) current assets, and (3) future income. The propensity to consume is greatest from the current income account, while sum designated as future income are treated more conservatively.

Total Returns as Priority. The best way to prevent mental accounting from weakening total returns is to remind your client that total returns are, after all, the number-one priority of any allocation. A renewed focus on global portfolio performancenot simply piecemeal aspects, such as principal or incomeis often achievable. As clients become more conscious of total returns, they will likely recognize the pitfalls of excessive mental accounting, and the problem will remedy itself.

Bias Name: Confirmation Bias Bias Type: Cognitive

Confirmation bias refers to a type of selective perception that emphasizes ideas that confirm our beliefs, while devaluing whatever contradicts our beliefs. For example, you may believe that more red automobiles drive by your house during the summer than during any other time of the year; however, this belief may be due to confirmation bias, which causes you to simply notice more red cars during the summer, while overlooking them during other months. This tendency, over time, unjustifiably strengthens your belief regarding the summertime concentration of red cars. To describe this phenomenon another way, we might say that confirmation bias refers to our all-too-natural ability to convince ourselves of whatever it is that we want to believe. We attach undue emphasis to events that corroborate the outcomes we desire and downplay whatever contrary evidence arises.

Confirmation bias can cause investors to seek out only information that confirms their beliefs about an investment that they have made and to not seek out information that may contradict their beliefs. This behavior can leave investors in the dark regarding, for example, the imminent decline of a stock.

Step toward overcoming confirmation bias is to recognize that the bias exists. Then people can mindfully compensate by making sure to seek out information that could contradictnot just confirmtheir investment decisions. It is important to remember that the mere existence of contradictory evidence does not necessarily mean an investment was unwise. Rather, uncovering all available data simply facilitates informed decisions. Even the most precisely calculated judgments can go awry; however, when investors make sure to consider all available contingencies and perspectives, they are less likely to make mistakes.

Bias Name: Hindsight Bias Bias Type: Cognitive

Described in simple terms, hindsight bias is the impulse that insists: I knew it all along! Once an event has elapsed, people afflicted with hindsight bias tend to perceive that the event was predictableeven if it wasnt. Therefore, people tend to overestimate the accuracy of their own predictions. This is not to say, obviously, that people cannot make accurate predictions, merely that people may believe that they made an accurate prediction in hindsight

In order to overcome hindsight bias, it is necessary, as with most biases, for the investors to understand and admit their susceptibility. Advisors should get their clients to understand that they are vulnerable and they counsel them on addressing specific problems that might arise.

Bias Name: Loss Aversion Bias Bias Type: Emotional

Win as if you were used to it, lose as if you enjoyed it for a change. Ralph Waldo Emerson
Loss aversion bias was developed by Daniel Kahneman and Amos Tversky in 1979 as part of the original prospect theory1 specifically, in response to prospect theorys observation that people generally feel a stronger impulse to avoid losses than to acquire gains. A number of studies on loss aversion have given birth to a common rule of thumb: Psychologically, the possibility of a loss is on average twice as powerful a motivator as the possibility of making a gain of equal magnitude; that is, a loss-averse person might demand, at minimum, a two-dollar gain for every one dollar placed at risk. In this scenario, risks that dont pay double are unacceptable.

1. Get-Even-itis. One effective remedy is a stop loss rule. You may, for example, agree to sell a security immediately if it ever incurs a 10 percent loss and if this 10 5 loss is not the periodic up and down but declining constantly.
2. Take the Money and Run: Loss aversion can cause investors to sell winning positions too early, fearing that that their profits will evaporate otherwise. 3. Unbalanced Portfolios: Loss aversion can cause investors to hold unbalanced portfolios. Education about the benefits of asset allocation and diversification is critical.

Bias Name: Recency Bias Bias Type: Cognitive The present is never our goal; the past and present are our means, the future alone is our goal. Blaise Pascal (16231662), French mathematician and philosopher Recency bias is a cognitive predisposition that causes people to more prominently recall and emphasize recent events and observations than those that occurred in the near or distant past.

Keep a detailed trade journal

Bias Name: Regret Aversion Bias Bias Type: Emotional

General Description. People exhibiting regret aversion avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove less than optimal. Basically, this bias seeks to forestall the pain of regret associated with poor decision making. It is a cognitive phenomenon that often arises in investors, causing them to hold onto losing positions too long in order to avoid admitting errors and realizing losses. Regret aversion also makes people unduly apprehensive about breaking into financial markets that have recently generated losses.

Bias Name: Framing Bias Bias Type: Cognitive

You better cut the pizza in four pieces, because Im not hungry enough to eat six.
Framing bias notes the tendency of decision makers to respond to various situations differently based on the context in which a choice is presented (framed). In real life, people usually benefit from some flexibility in determining how to address the problems they face.

Bias Name: Status Quo Bias Bias Type: Emotional

status quo bias operates in people who prefer for things to stay relatively the same. The scientific principle of inertia bears a lot of intuitive similarity to status quo bias; it states that a body at rest shall remain at rest unless acted on by an outside force.