Investing for Survival---biases that make you
do dumb things with Your Money
6. Frequency illusion
Once you notice an event, it seems to keep happening over and over. But it's often not; you're just paying more attention to something you were once oblivious to. The 2008-09 market crash was such a memorable event that I think investors and the media became infatuated with today's "volatile market." But the last three years have actually had below-average market volatility. We're just more attuned to normal market swings than usual.
Once you notice an event, it seems to keep happening over and over. But it's often not; you're just paying more attention to something you were once oblivious to. The 2008-09 market crash was such a memorable event that I think investors and the media became infatuated with today's "volatile market." But the last three years have actually had below-average market volatility. We're just more attuned to normal market swings than usual.
7. Clustering illusion
Thinking you've found a pattern by taking a small sample out of a much larger one. For example, we know stocks' daily movements over time are random and unpredictable, but you could take a four-day period where a stock went up, up, down, down, and think you've found a trend. Day traders are attracted to clustering like bugs to bright lights.
Thinking you've found a pattern by taking a small sample out of a much larger one. For example, we know stocks' daily movements over time are random and unpredictable, but you could take a four-day period where a stock went up, up, down, down, and think you've found a trend. Day traders are attracted to clustering like bugs to bright lights.
8. Status quo bias
Irrationally wanting things to stay the same. People do this in part because they want to avoid costs even when they're offset by a larger gain -- a process psychologists call "loss aversion." You stick with the same bank even though it charges higher fees than another. You hold onto a stock you inherited even when you know little about it. You don't make changes to your portfolio even when it's not designed for your goals. You just want things to stay the same -- a dangerous mind-set in a world that's always changing.
Irrationally wanting things to stay the same. People do this in part because they want to avoid costs even when they're offset by a larger gain -- a process psychologists call "loss aversion." You stick with the same bank even though it charges higher fees than another. You hold onto a stock you inherited even when you know little about it. You don't make changes to your portfolio even when it's not designed for your goals. You just want things to stay the same -- a dangerous mind-set in a world that's always changing.
9. Belief bias
Accepting or rejecting an argument based on how well it fits your pre-defined beliefs, rather than the objective facts of the situation. Pointing out that inflation has been low for the last five years is still met with suspicion by those who believe the Federal Reserve's actions must be causing hyperinflation.
Accepting or rejecting an argument based on how well it fits your pre-defined beliefs, rather than the objective facts of the situation. Pointing out that inflation has been low for the last five years is still met with suspicion by those who believe the Federal Reserve's actions must be causing hyperinflation.
10. Curse of knowledge
When educated people can't comprehend that lesser-educated people think and act differently from them. Financial advisors and journalists fall for this all the time, spouting off lingo and catch phrases without realizing their customers have no idea what they're talking about (and are too afraid to ask for clarification). This also explains why there's a wide gap between academic theory and real-world reality. Economists who understand finance wrongly assume lay people will act in their best interests. Wall Street banks rightly assume they won't.
When educated people can't comprehend that lesser-educated people think and act differently from them. Financial advisors and journalists fall for this all the time, spouting off lingo and catch phrases without realizing their customers have no idea what they're talking about (and are too afraid to ask for clarification). This also explains why there's a wide gap between academic theory and real-world reality. Economists who understand finance wrongly assume lay people will act in their best interests. Wall Street banks rightly assume they won't.
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