Six traps investors should mind and avoid
PERSPECTIVES: Take note of these behavioural traps that investors fall into time and time again
1) Anchoring trap. The mind gives a disproportionate amount of weight to the first information received on a topic. Keeping an open mind and avoiding premature conclusions is a way to avoid this trap.
2) Status quo trap. Forecasts tend to perpetuate recent observations. If inflation has been high, it is expected to remain high. It is a psychological risk to assume something different. The authors suggest rational analysis within decision-making to avoid falling into this trap.
3) Confirming evidence trap. Individuals give greater weight to information that supports an existing point of view. Being honest to oneself about one's motives, examining all evidence with equal rigour, and enlisting independent-minded people to argue against you are ways of mitigating this bias.
4) Overconfidence trap. Individuals overestimate the accuracy of their forecasts. Widening the range of expected possible outcomes is one way to mitigate this tendency.
5) Prudence trap. There is a tendency to temper forecasts that appear extreme. If a forecast turns out to be extreme and then wrong, it could be damaging to one's career. Therefore, sticking to the herd is safer. The authors again suggest widening the range of expected possible forecasts to avoid falling into this trap.
6) Recallability trap. Individuals are overly influenced by events that have left a strong impression on a person's memory. These events tend to be catastrophic or dramatic. To avoid falling into this trap, individuals should ground their conclusions in objective data rather than emotion or memories.
There is some overlap between these traps and the investor biases we discussed a few weeks ago and the psychological tendencies as described by Charlie Munger. Investors should get to know these traps so thoroughly that they recognise and immediately mitigate when they are about to fall into one.
Barel Karsan Value Investing blog is all about finding current value investments, and always applying a margin of safety!
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