Bias’s that boost the ego!

Investors can have all sort of biases that can prove detrimental to their investment choices and behavior. By bringing to identify yourself and taking mitigating actions you can avoid these pitfalls. Remember prevention is always better than curing.

In previous posts we covered confirmation, conservation, representative and anchoring bias. Biases in how we think, Now we look at more dangerous biases, ones that that boost our ego, illusion of control and hindsight bias.

Financial Markets can be unpredictable, there are so many variables even the most informed investors can’t keep up with how all interact all the time, if you think each time you invest you have 90% probability of success, you may be suffering from illusion of control. This happens when people think they have control over outcomes, when infact they cannot. Some factors such as corporate performance and economic conditions represent uncertainty that the investor cannot control.

The problem with this bias is it can cause you to trade more than is prudent, as you overestimate the number of successful investment decisions you will achieve. It may also cause you to take excessive risk, usual the size of the position you take is dependent on how confident you are in your analysis, if you are overconfident, you will over expose. This can also result in under diversified portfolios as you eggs in the one basket you are so sure off

Helping you overcome this bias is to recognize the uncertainty inherent in every investment decision, adjusting your probability of success accordingly. Second keep records of the rationale behind your trades to help self evaluation of past decisions, this will help you appreciate past mistakes more.

Only after things have already happened do we assume to see how easily it would have to predict it, that’s hindsight bias, when infact at the time it wasn’t all that clear. Everybody now talks about how the financial crises of 2008 was inevitability, yet very few people saw it coming

at the time. This bias also happens when people think their predictions were more accurate than they actually are biased by after the fact perspective, they reconstruct memories.

Hindsight bias by overestimating the correctness of you initial prediction can lead to overconfidence bias, which again can lead to excessive trading and risky exposures. It can also bias comparisons and evaluations, for example if you are looking for an investment manager or fund to invest in, you should compare their performances with the information available at the time, not after the fact, as its not reasonable to assume the investment manager should have seen it coming when back then it was an uncertainty.

So in conclusion, don’t overestimate you ability before the fact or after the fact!