Information-processing Biases: Reasons for Risky Investments

Let's start with a question.

Suppose you have two equal amounts of money.

One $1,000 is from lottery winning, and the other $1,000 is from your hard work.

Would you treat them in the same way?

Probably not.

It suggests a mental accounting bias, one information-processing bias.

It differentiates accounts according to the sources and intended uses of money.

Here's another question.

If Fund A has an 80% chance of making a profit, and Fund B has a 20% chance of losing money, would you prefer Fund A?

When you say yes, you are likely to have a framing bias.

It is also an information-processing bias, concluding differently based on various descriptions of the same thing.

Next, I will walk you through two other common information-processing biases.

Sometimes, the crew uses an anchor to secure the boat in one place.

Investors also tend to find an anchor to help make decisions, such as an expected price or economic forecast.

Let's look at a case.

You bought a stock at $500 and expected it to rise to $1000 in three months.

It rose to $700 soon but fell to $300 two months later and seemed to maintain the price.

If you were still holding on to your anchor, you might have been affected by the anchoring and adjustment bias.

This bias refers to the fact that people determine a value that is an anchor to evaluate unknown values in the future.

Sometimes the anchor helps with expectations, and we will adjust it accordingly.

However, in some cases, we may not be able to make adequate and timely adjustments, which results in significant deviations between the forecasted and actual values.

This may lead to risky investments.

To reduce its negative effects, here are some tips for you.

Firstly, awareness is the first step toward change. Gain awareness of anchoring and mood or personality that reinforce its effects.

Then, keep your eyes on developments.

That is not to say you shouldn't have an anchor, but don't exaggerate it.

Also, cheer yourself up. Improving your experience, skills, and cognitive abilities can help bring a better anchor and attitude toward it.

After learning the anchoring and adjustment bias, let's move on to another bias.

Let's think about four types of information.

The first one is about retrievability.

Generally, the more you are exposed to something, the easier it is for you to recall it in your mind.

After seeing news about people losing their jobs, you might be greatly concerned about being fired.

After seeing many downtrend predictions, you may have a pessimistic expectation of future stock trends.

But that may not be the case.

The second type is categorization.

Your brain might have "search sets".

For example, you tend to believe falling prices are caused by specific reasons and ignore other possibilities.

The third type is about your narrow range of experience.

You might have an idea of investing in the sector you work in, even though it doesn't have better prospects than others.

The last type is resonance. What you like catches your attention more.

However, your allocation could be inefficient if your investment is based on your preferences rather than data, risks, and returns.

Investing decisions based on the above available information shows the effects of availability bias, which may bring risks.

To avoid getting trapped by it, you'd better arm yourself with "weapons".

One weapon is a camera.

It helps you recognize the availability bias and see the bigger picture.

The second is a scale.

Stay critical, have an objective perspective, self-reflect, and avoid making impulse decisions by weighing the available information.

The last weapon is a telescope.

Stay open and see further.

Remember, the first solution that comes into your mind might not be the best. Many potential solutions are waiting for you.

Understand information-processing biases better now? Please share your thoughts with us.