Availability Bias Clouds Our Judgement
Our next investor bias has been known to cause us to over-react to the possibility of certain events. This bias is known as availability bias and is sometimes referred to as availability heuristic. Availability bias causes us to overestimate the probability of the occurrence of a particular event. It is a function of how easy it is for us to recall examples of the particular event. This is especially the case if we have been affected directly by the low probability event, and also when there has been a recent example that comes to mind.
Events that draw a great deal of media attention are prime candidates for availability bias. Good examples are plane crashes, earthquakes and terrorist attacks. People consistently overestimate the frequency of these events because they always generate substantial media headlines. Memorable events get magnified in importance and are likely to cause an emotional reaction.
As noted previously, emotional reactions can cause investor mistakes. History has shown that well diversified stock portfolios tend to increase in value in about seven out of ten calendar years. However, some people refuse to invest in equities simply because they recall a negative year. First hand experience with the negative return can be particularly difficult to overcome as the pain is indelibly burned into our psyche. A rational decision maker would keep in mind that the majority of years post positive returns but as we have seen with other behavioral biases, investors are often far from rational. Headlines satisfy our human need for coherence and require less effort than applying statistical reasoning. Good investing requires us to be aware of these biases and not to allow them to overly influence our thought processes.
If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
