February 24, 2018

Let's begin our discovery of behavioral biases by defining what a bias is:

Let’s begin our discovery of behavioral biases by defining what a bias

is:

bias |ˈbīəs|

noun

prejudice in favor of or against one thing, person, or group compared with another, usually in a way considered to be unfair: there was evidence of bias against foreign applicants | the bias toward younger people in recruitment | [ in sing. ] :  a systematic bias in favor of the powerful.• [ in sing. ] a concentration on or interest in one particular area or subject: he worked on a variety of Greek topics, with a discernible bias toward philosophy.• Statistics a systematic distortion of a statistical result due to a factor not allowed for in its derivation. Source New Oxford American Dictionary.

According to the book, Behavioral Finance and Wealth Management, authored by Michael M. Pompian, “Numerous research studies have shown that when people are faced with complex decision-making problems that demand substantial time and cognitive decision-making requirements, they have difficulty devising a rational approach to developing and analyzing a proper course of action. This problem is exacerbated by the fact that many consumers need to contend with a potential overload of information to process.”

Pompian goes on to say that “by understanding the effects of behavioral biases on the investment process, investors and their advisors may be able to improve economic outcomes and attain stated financial objectives.”

In our Behavioral Biases Series (BBS), biases are classified as either cognitive or emotional biases.

As Pompian goes on to say, “In that context, cognitive biases are basic statistical, information processing, or memory errors that cause the decision to deviate from rationality. Emotional biases are those that arise spontaneously as a result of attitudes and feelings and that cause the decision to deviate from the rational decisions of traditional finance.”

In the weeks ahead, we will review cognitive and emotional biases and their implications for financial decision making, and suggestions for correcting for the biases.

Next week we will begin our examination of cognitive biases.

Gary W. Lendermon

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