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The Art of Thinking Clearly: Part 7

Moving on with even more biases as revealed in Rolf Dobelli’s excellent book, “The Art Of Thinking Clearly,” here are three more biases that could trip us up and severely impair our investment decision-making process.

Omission bias

This bias tells our brains that passivity is often preferred to activity, even though both may result in similar outcomes. Omission, therefore, seems to be more acceptable than commission (i.e., making a mistake by undertaking an action). I’ve written on the two types of investing errors before, and the omission bias makes an investor more comfortable in holding on to a bunch of dud companies, as compared to actively buying lousy ones.

Notice that in the above example, the end result is the same: The investor is still stuck with a bunch of lemons. However, if he had omitted to take any action (i.e., simply let his portfolio languish), his mind is able to accept it better than if he actively selected and bought poor companies. We need to guard against omission bias because sometimes, taking action (to eliminate poor investments) is indeed preferable to just sitting idly by and suffering.

Self-serving bias

This is an extremely pervasive bias among investors, as many of them attribute failure to external events and success to themselves. Most of the time, the truth is that failure is the sole result of poor investment decisions made, while success may be due to a series of random events rather than the innate skill of the investor.

To be fair, each investment case has to be evaluated on its own merits, and we cannot pass judgement so easily or simply. But the problem with the self-serving bias is that it blinds investors to their own faults, which then leads to failures that are never corrected. Remember that documenting mistakes made is just a first step, the next step is for the investor to acknowledge his own fallibility and take responsibility for poor decisions made.

Association bias

This bias means we tend to associate bad news with the bearer of the bad news, even though they are two separate things. Thus, investors and CEOs end up only hearing the good stuff, as no one likes to be the bearer of bad news. This ends up creating a bias in terms of what people actually know, creating a distortion of reality. Investors who hear only good news tend to underestimate risks or be blind to their existence — simply because no one can bear to be associated with the bearer of bad news. So, remember, the next time you seek news updates on a company, specifically instruct your friend to tell you the bad news first!

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