 | Mental Accounting. This is the tendency to value some dollars
less than others. One example of this is the "House Money" effect: if
you are gambling at a casino and you have been fortunate enough to win, you
might tend to be more risk-seeking with your earnings than you would be with
your principal. For more information, see the
excellent paper
here (2.4mb). |
| Loss Aversion. This is the tendency to feel more pain by
losing money than you would feel satisfaction in gaining an equal amount of money. |
| Myopic Loss Aversion. This is the tendency to focus on
avoiding short-term losses, even at the expense of long-term gains. For
example, this explains why people tend to buy insurance policies with low
deductibles and low limits, despite it being opposite to what is clearly in
their long-term best interests (i.e., most people would be best served with
high deductibles and high coverage limits). For more information, see
the excellent papers
here (1.1mb),
or the excellent article
here. |
| Sunk Cost Fallacy. This is the tendency to "throw good money
after bad." It is related to Regret Aversion and Loss Aversion. |
| Status Quo Bias. This is the tendency to want to keep things the
way they are. |
| Endowment Effect. This is the tendency to consider
something you own to be worth more than it would be if you didn't own it. |
| Regret Aversion. This is the tendency to avoid taking an
action due to a fear that in hindsight it will turn out to have been less
than optimal. |
| Money Illusion. This is a confusion between "real"
and actual changes in money (i.e., time value of money and inflation
effects). |
| Bigness Bias. This is the tendency to pay more attention to
big numbers than small numbers (e.g., we are more impressed by the fact that
a particular mutual fund had a 50% return last year than we are discouraged
by the fact that the same fund has an expense ratio of 3% and a sales load
of 5%). |
| The Law of Small Numbers. This is the tendency to exaggerate
the degree to which a small sample resembles the population from which it is
drawn. This is related to the Recency bias. |
| Recency Bias. We tend to associate more importance to
recent events than we do to less recent events (e.g., during the great bull
market of '95-'99, many people implicitly presumed that the market would
continue its enormous gains forever, forgetting the fact that bear markets
have tended to occasionally happen in the more distant past). This is
related to the Law of Small Numbers. |
| Anchoring. This is clinging to a fact or figure that should
have no bearing on your decision. Often, we use an initial value as a
"starting point" in decision making. Even if the initial value was a
totally random uneducated guess, we tend to be biased towards it. |
| Confirmation Bias. This is the tendency to look for, favor,
and be overly persuaded by information that confirms your initial
impressions. Conversely, we tend to ignore and dismiss information
which tends to disprove our initial impressions. For more
information, see the outstanding discussion
here. |
| Overconfidence. This is the tendency to overestimate our own
abilities (i.e., we aren't as smart as we think we are). People tend to
think that they are much better forecasters and estimators than they actually
are. |
| Optimism. People tend to be optimistic about the future.
This might also be termed, "wishful thinking." |
| Information Cascades. This is the tendency to ignore
our own objective information and instead focus on emulating the actions of others
(e.g., the tendency to sell a stock solely because others are bidding the
price down, or buying a stock solely because others are bidding the price
up). This is also known as "herding." For more information, see
the discussion
here
or the papers here
and here. |
| False Consensus. This is the tendency to think that others
are just like us. |
| Weakness of Will. This is the tendency to consciously do
things which we sincerely know are wrong. A non-financial example
includes smoking cigarettes (we know we shouldn't do it but many do it
anyway). A financial example includes living within our means (we know
we should do it, but we often don't). |
| Credulity. While we might like to believe that we are all
perfectly rational, reality is far different. Unfortunately, we tend to
be susceptible to the manipulative messages that the financial industry and
the popular press put out. Specifically, mutual fund companies tend to
conspicuously advertise positive information, while suppressing negative
information. The popular press encourages conventional wisdom on
investing issues because it helps them sell magazines (despite being provably
wrong). |
We believe the information provided here to be useful and accurate at the time
it is written.
Information contained herein has been obtained from sources believed to be
reliable, but is not guaranteed.
No investor should invest solely on the basis of information listed here.
Before investing, it is important to consult each prospective investment's
prospectus and consider both its risk/return characteristics and its effect on
your overall portfolio.
This information is not intended to be a
substitute for specific individualized tax, legal, or investment planning
advice. Where specific advice is necessary or appropriate, Altruist
recommends consultation with a qualified tax adviser, CPA, financial planner, or
investment adviser. If you would like to discuss the rationale or support
for any particular idea expressed on this web page, feel free to
contact us.
