Beatles Breakdown: Your Behavioral Biases Toward Investing – Part 3

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Think you can beat the markets? Research shows that you have a bigger hurdle to face: First, you have to beat your own sneaky brain. With a little help from your friends at the Wherewithal blog, you can understand the biases that trip up even the most coolly logical of investors.

In Part One, we covered beginners’ mistakes. In Part Two, we described the kinds of biases that affect more experienced investors.

Part Three tackles errors over which even the longtime investing pros can stumble. They are human, after all. Those are:

1. Cognitive dissonance
2. Overreaction bias and availability bias
3. Status quo bias
4. Attachment bias

Just for fun, we found well-known Beatles tunes that seem to have explained it all in advance.

1. Cognitive dissonance

“He’s as blind as he can be, just sees what he wants to see” (Nowhere Man): Strangely, we have a way of forgetting painful investment losses and remembering too well when we were right about a strategy. A bias known as “cognitive dissonance” thus creates the risk that you see what you want to see and ignore what doesn’t fit your beliefs. Seeking out “facts that fit” also is known as confirmation bias.

2. Overreaction bias and availability bias

“But tomorrow may rain, so I’ll follow the sun” (I’ll Follow the Sun): Markets process information perfectly, right? Not so much. One of the problems with new information is that it often creates a need to act, an emotion that in retrospect can seem an overreaction. Experts called this overreaction bias.

New home sales data or a regional manufacturing index update isn’t going to change the prospects for any given company, and these kinds of numbers often are heavily revised. Nevertheless, stocks can sell off or get a pop upward just on a headline, then revert once the market realizes the reaction error. Similarly, “availability” bias gives “new” news more weight, even if that information doesn’t amount to much.

3. Status quo bias

“Day after day, alone on a hill, the man with the foolish grin is keeping perfectly still” (The Fool On the Hill): Hate going to the grocery store? Of course you do. There are far too many choices. Faced with an array of investments, people tend to stick with what they already have. This is “status quo” bias. In effect, people prefer to make no choices at all, even if they should adjust holdings to reflect a changing tolerance for risk, such as getting older. It’s the reason why so many 401(k) holders are sitting on cash, year after year. Cash was the default position in their portfolio.

4. Attachment bias

“Should five per cent appear too small, be thankful I don’t take it all” (Taxman): Research has found that buy-and-hold investors have a hard time letting go of stocks that have served them well. Of course, the list of former blue chip giants in the dustbin of market history is long: GM, Enron, Polaroid, TWA. This is known as “attachment bias.”

Taxes play a role. Even with the relative break of the long-term capital gains rate, sometimes a stock appreciates so dramatically that it becomes impossible to sell it, so nobody will. Then it goes bankrupt in six months, taking down billions in personal wealth.

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