Baises of investor final
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This document discusses various cognitive biases that can affect investment performance. It identifies 12 common biases: overconfidence, familiarity, anchoring, confirmation bias, mental accounting, illusion of control, recency bias, hindsight bias, herd mentality, representativeness, self-attribution bias, and trend-chasing bias. These biases can cause investors to ignore evidence, become overly concentrated, rely too heavily on past information, and make decisions based on social and emotional factors rather than objective analysis. Avoiding cognitive biases allows investors to make impartial decisions based solely on available data.
Baises of investor final
- 1. “Biases Affecting Investment Performance” Course: Investment Analysis Course Code: FIN 4705 Prepared for Dr. Jannatul Ferdaous Assistant Professor Faculty of Business Studies Bangladesh University of Professionals Prepared by Saeed Ahamad ID- B1304048 BBA-4 Bangladesh University of Professionals Mirpur-12, Dhaka 1216
- 2. Biases Biases are human tendencies that lead us to follow a particular quasi-logical path, or form a certain perspective based on predetermined mental notions and beliefs. When investors act on a bias, they do not explore the full issue and can be ignorant to evidence that contradicts their initial opinions. Avoiding cognitive biases allows investors to reach impartial decision based solely on available data. 1. Overconfidence: confidence can easily turn into overconfidence after a few easy wins. Many novice investors get lucky: The first few stocks they pick do extremely well. Unfortunately, they start believing in themselves. They think they have a magic touch; or worse, they think they are smarter than everyone else. This often leads to disaster. 2. Familiarity: familiarity bias may cause some investors to be too concentrated on opportunities in their own countries. They are more familiar with and confident about local investment opportunities, so despite the fact that it’s much easier than in the past to diversify investments across geographies, they go with what they know and can easily understand. 3. Anchoring: The idea of anchoring becoming fixated on past information and using that information to make inappropriate investment decisions. 4. Confirmation bias. People are often drawn to information or ideas that validate existing beliefs and opinions. For example, many TV viewers prefer a news channel that represents their own political views, avoiding those featuring commentators of different opinions. 5. Mental accounting: Mental accounting can manifest itself in a few ways. Money earned at a job may be viewed differently than money from an inheritance. This can affect the way the money is spent or invested. Mental accounting shows up in investor portfolios, too. “People get emotionally tied to certain stocks,” Wire says. She recalls a particular
- 3. elderly woman who wouldn’t part with a large holding of stock in a local bank started by a family member. Wire says it’s a fairly common problem. 6. Illusion of control bias: After a prominent plane or train crash, it’s not hard to find online commenters proclaiming a preference for travel by car, saying they feel more in control when driving. Many are resolute in this preference despite decades of research showing that air and rail are statistically much safer. A similar thought process applies to some people’s investing decisions. “The illusion of control begins with the word ‘should,’ as in, 'I should be able to pick the right stocks,' or 'someone should have the ability to time the market to achieve superior results consistently,'” 7. Recency bias: When gas prices fall, sales of large sport-utility vehicles and trucks tend to rise. It’s not difficult to see the connection: Consumers believe what’s happened recently will continue to happen. 8. Hindsight bias: “I knew that would happen.” Who hasn’t said or heard that, probably many times? “Humans tend to overestimate the accuracy of their predictions. This can be costly as we get a false sense security when making investment decisions, which can lead to excessive risk-taking behavior and place people’s portfolios at risk,” Porter says. 9. Herd mentality: Rugged individualists aside, people are social animals. Marketers know this, and have become adept at creating social proof that since other buyers like their products, so should you. It’s another type of thought process that takes hold when a person doesn’t want to be left out of a trend or a movement. 10. Representativeness: Representativeness results in investors labeling an investment as good or bad based on its recent performance. Consequently, they buy stocks after prices have risen expecting those increases to continue and ignore stocks when their prices are below their intrinsic values. Investors should have a clearly defined analytical process that they test and retest in order to refine and improve it over the long run.- Regret (loss) aversion.
- 4. 11. Self-attribution bias: Investors who suffer from self-attribution bias tend to attribute successful outcomes to their own actions and bad outcomes to external factors. They often exhibit this bias as a means of self-protection or self-enhancement. Investors afflicted with self-attribution bias may become overconfident, which can lead to overtrading and underperformance. Keeping track of personal mistakes and successes and developing accountability mechanisms such as seeking constructive feedback from others can help investors gain awareness of self-attribution bias. 12. Trend-chasing bias: Investors often chase past performance in the mistaken belief that historical returns predict future investment performance. Mutual funds take advantage of investors by increasing advertising when past performance is high to attract new investors. Research evidence demonstrates that investors do not benefit because performance typically fails to persist in the future.