Biases and descriptions source: Business Insider-20 Cognitive Biases that Screw Up Your Decisions
In part four of this series, we highlight salience bias, selective perception bias, stereotyping bias, survivorship bias and zero-risk bias. Learn how they relate to investing and what you can do to guard against them.
By understanding and guarding against the common biases, you’ll have a better chance of making optimal decisions and achieving your desired outcomes.
16. Salience Bias
Salience bias describes our tendency to focus on information that is more noteworthy while ignoring information that does not grab our attention. Often these are the things that have happened most recently.
Investors often respond to market moves and the latest news cycle, but how often do they go back to the investment’s long-term track record or risk metrics?
What can you do to guard against salience bias?
Salience bias occurs when we base our decisions on factors that appear most significant to us. When we are aware of the bias, it can enable us to step back and properly evaluate the upcoming decision.
Though maintaining an awareness of the bias will not ensure all decisions are always well-informed, it can help mitigate some of the more detrimental impacts.
17. Selective Perception Bias
Availability bias describes our tendency to be over-reliant on the information that is immediately and readily available to us.
As humans, we believe what we want and see what we want. We seek out information that supports our beliefs versus seeking data to the contrary. It’s the reason different people may perceive the same situation differently.
For example, investors tend to notice only the information that supports their positions while forgetting about all the ones that do not.
What can you do to guard against selective perception bias?
Biases often arise because, when faced with a lack of relevant information, your brain latches onto whatever it encountered first, most recently or most easily, defaulting to something simple or familiar.
A solution to overcoming this tendency is to acquire as much relevant information as you can before making decisions and to take your time. Most biases exist as mental shortcuts. If we take more time to analyze, we are less likely to fall back on the shortcut. This may help in avoiding all the selective perception biases, including availability, anchoring and recency.
18. Stereotyping Bias
Stereotyping is the tendency to make decisions based upon the similarity to some stereotype or archetype of an event, rather than the underlying fundamentals.
The problem with stereotyping is that it is used all the time because it’s pretty effective. If you have to make a split-second decision about something, the stereotype typically has some accuracy or truth behind it.
When it comes to investing, we very rarely need to make split-second decisions. We can take the time to research and find out what are the underlying facts.
What can you do to guard against stereotyping?
Here are two things to try:
Take a broad view. Look at the big picture and if it helps to use stereotypes for good, think of some opposite stereotypes than the particular ones that come to mind.
Avoid confirmation bias. Confirmation bias is the tendency to look for confirming evidence as opposed to disconfirming evidence. You need to purposely say, what are the things that are different that should make me change my mind?
19. Survivorship Bias
Survivorship bias occurs when an individual only considers the surviving observations without considering the data points that didn’t survive in the data set.
Survivorship bias is especially relevant in our financial systems. When investors calculate or look at the performance of investments, such as mutual funds, it typically only includes the data from the funds still surviving at the end of the period. Funds that no longer exist, typically due to poor performance, are excluded from the results. Omitting them from returns data usually skews the results in an overly positive light.
What can you do to guard against survivorship bias?
Once individuals learn about survivorship bias, they can avoid the bias by considering what data might be missing and using accurate data sources that do not omit key observations.
Ask yourself what you don’t see
When making a decision, begin by considering what’s missing. What data didn’t survive from a dataset you are using?
Vet your data sources
Another method to prevent survivorship bias is to be selective of the data sources used. Try using data sources that do not omit critical observations to reduce the risk of survivorship bias.
Being fully informed and taking the time to pause, reflect and research all the data will help ensure the consideration of survivorship bias in your decision-making process.
20. Zero-risk Bias
Zero-risk bias plays on our preference for absolute certainty. It’s the tendency to opt for complete risk elimination, sometimes over an alternative that offers more favourable predicted outcomes overall.
Have you ever bought an insurance policy for something that you felt was near impossible? We know that these hypotheticals are highly unlikely, but the thought of such an event can be deeply unsettling. Although the policy might not be worth the premium we pay, part of what we are buying is the peace of mind in knowing we’ve eliminated the potential risk.
People are not calculators. Most do not consciously deliberate the exact probabilities of all events. Instead, they often gauge a decision by how they feel about it. Even a 1% chance of disaster can loom over our conscience so securing that 0% can be a favourable outcome.
What can you do to guard against zero-risk bias?
While it’s not always easy to stop and think about what a rational actor would do, it helps to assess your decision-making process and see how much fear of a potential loss is guiding your preference towards a particular choice. Probe yourself on how much the allure of zero-risk is influencing your preferences and whether it’s more important than a greater reduction in risk.
Want to learn how dealing with an experienced advisor and following a disciplined investment process can help mitigate the risk of falling prey to cognitive biases and keep your investment goals on track?
Anchor Pacific Investment Management Corp. (“Anchor Pacific”) is a Vancouver, BC-based portfolio management firm, which leverages process, technology, and infrastructure to democratize the process of managing endowment and pension style investment portfolios to deliver innovative, high-touch, and transparent investment programs across the full spectrum of asset owners and investment consumers.