- Psychological biases can influence investors' decision making and lead to poor outcomes. Some of the key biases discussed include framing, loss aversion, anchoring, hindsight bias, confirmation bias, cognitive dissonance, and representativeness. - Framing refers to how outcomes are evaluated based on whether they are viewed as gains or losses from a reference point. Loss aversion describes people's tendency to strongly dislike losses compared to liking equivalent gains. - Anchoring occurs when initial reference points unduly influence subsequent decisions. Hindsight bias is the tendency to view past events as more predictable than they were. Confirmation bias leads people to seek information confirming existing views.

1. Psychological Biases
"The financial markets are generally unpredictable. The idea that you can actually predict what’s going to happen
contradicts my way of looking at the market." George Soros
FRAMING: The concept of framing can best be explained via an example… assume you are in a shopping centre,
standing outside both David Jones and Myer, and you are looking to buy a TV. David Jones is offering the one you are
after for $1000, whilst Myer is offering the same one for $950. However, David Jones is also offering a $50 discount
for cash, whilst Myer charges a $50 surcharge for credit cards. All other things being equal, which department store
would you buy from? Most people report a preference for David Jones, the store offering a cash discount.
This is bizarre in a way, as both department stores are offering exactly the same deal; a price of $950 for cash or
$1000 for credit card. But this preference can be explained in terms of how the question or problem is framed.
Humans evaluate outcomes in terms of losses and gains from their current, neutral state, which can be described as a
starting point of sorts. So in the David Jones example, it appears your starting point is $1000 and you are then offered
a saving of some money, which is a gain or improvement from your starting point. However, in the Myer example,
your starting point is $950 and yet, you are faced with a potential increase in price, which is a loss or decline from
your starting point.
The psychology behind this relates to the fact that humans treat losses of a given amount far more seriously than
gains of an equivalent amount. This phenomenon is explained in greater detail below, as loss aversion is closely
related to framing.
So how exactly does framing relate to investing? The best way to answer this is to give you the following, rather well-
known example. Assume that the outbreak of a new disease is expected to kill 600 people. Assume also that two
alternative programs have been proposed to address the problem.
In the first set of options, Program A will result in 200 people being saved, whereas Program B will result in a one
third probability that 600 people will be saved, but two thirds probability that no one will be saved. Roughly 75% of
people elect Program A as the preferable one.
Now for a second set of options. Program C will result in the death of 400 people, whereas Program D will result in a
one third probability that no one will die, but two thirds probability that 600 people will die. Roughly 75% of people
choose Program D as the preferable one.
Isn’t this bizarre when you consider that Program A is the same as Program C, but framed differently, and Program B
is the same as Program D, but framed differently. And yet people go with Program A and D!
The reason for this is that when information is framed as a gain, people generally go with the guaranteed option.
However, when information is framed as a loss, people generally go with the risky option. The first set of options
used the word ‘save’ (framed as a gain), whereas the second set of options used the word ‘die’ (framed as a loss).
And this exact phenomenon is seen in the stock market! When making money on a trade (a gain), people often take
the guaranteed option by taking profits and locking in that ‘guaranteed’ gain. However, when losing money on a
trade (a loss), most people choose to take the risky option by running losses and holding the stock. And yet, any
market expert will tell you that good investors do the exact opposite, which they do… they cut their losses and run
their profits! Consider what your portfolio will look like if you sell all profits and hold all losses… as mentioned
earlier, you will end up, as most junk collectors do, with a portfolio of rubbish.
So try to bear in mind that on account of the phenomenon of framing, your instincts are pushing you to take your
profits and run your losses. Do your best not to succumb to this, as cutting losses and running profits is a far wiser
course of action.
LOSS AVERSION: The effects of framing can be explained by human beings’ aversion to loss. There have actually
been some studies which suggest that losses can be as much as twice as psychologically powerful as gains. And from
an evolutionary psychology perspective, this makes a great deal of sense when you think about it. If you only have
$1000, making $1000 would give you $2000, but losing $1000 would wipe you out entirely. And given the human

2. need for money to procure food and shelter, it is far more motivating to avoid losing that $1000 than it is to make
that $1000. So how does all this relate to the world of investing?
The aversion to loss is so great with most investors that the thought of selling a stock when one is down (showing a
paper loss) is truly abhorrent and too painful to face. Many investors hang on to losing stocks in the hope that one
day, the stock will come good. They do so even when there is no information to suggest this recovery will occur. In
other words, their distaste for losses renders them unable to make a sound investment decision when losing money
and they start to gamble.
But refusing to sell a stock when it is down (unless there is a good reason to hold) is akin to a failure to acknowledge
reality. Many investors continue to hold loss-making stocks in the hope they will one day recover. Take the loss (good
for your tax return!), move on and get your money working for you again. The reality is that investing must be based
on logic and rational decision- making, not hope and blind optimism.
The moral of the story here is to never let your distaste for losses cloud your investing judgment. Losses hurt, but
don’t hide from reality… accept the loss and move on. Don’t let your decision-making be compromised. And you’ll be
surprised how much better you feel once you finally take that loss and move on. It’s a weight off your shoulders… just
because you hadn’t sold before doesn’t mean that the as yet unrealised loss didn’t bother you. It probably bothered
you on a daily basis, keeping you awake at night.
The fact is that every single investor in the world will make mistakes and be faced with the need to take losses at
some point. If this decision cannot be made quickly and without emotion, it is only a matter of time before an
investor ends up with a portfolio full of loss making failures, as they are the only investments they refuse to sell.
ANCHORING: The next decision-making error is a phenomenon known as anchoring, and this often clouds people’s
judgment when it comes to investment decisions.
So what is anchoring exactly? As mentioned, humans use mental shortcuts to assist in decision-making and
information processing. Anchoring is one such shortcut. The human brain selects an initial reference point and bases
decisions around that point. As an example, when a salesperson sets an initial price for an item, they usually set it
higher than the real value for the item in an effort to extract the highest possible price by setting an anchor in the
consumer’s mind. During the bargaining process, the initial asking price (or anchor) serves to set the initial tone for
what the item might be worth, and any final price is set with the initial anchor in mind.
For example, if a home is offered by an agent at $1m, even though the seller wants $800,000, the $1m sets an anchor
in the minds of prospective buyers. And so if a buyer ends up purchasing the property for $900,000, they feel that
they have made a wise purchase as they compare the result to the anchor (initial reference point), even though that
figure ($1m) was somewhat arbitrary and probably unrelated to the value of the property.
To demonstrate how this mental shortcut can be a pitfall to good investing, consider an investor who sees a stock fall
substantially from its highs and goes to purchase in an effort to do a bit of bottom-fishing or bargain hunting.
Multiplex (MXG) would be a good real-life example to use here. Say an investor witnessed the stock drop from $5.75
in February 2005 to $4.50 in March 2005, one month later. That investor uses the initial reference point (the anchor),
being the February price of $5.75, as evidence of value, and so in comparison, the March price of $4.50 seems very
cheap. Of course, the stock went on to plumb lows of $2.89 after that. Clearly, whilst $4.50 was much lower than the
February price of $5.75, it was not good value and so the anchor of $5.75 served only to misguide investors.
Hopefully, this example demonstrates the dangers of placing emphasis on the anchor. It is natural for the brain to
select an anchor (as a shortcut) around which to make decisions, but don’t let anchors influence your decision-
making when it comes to investing. This shortcut may have evolved as it is useful in other areas of your life, but when
it comes to investing, it often leads to poor decision-making.
HINDSIGHT BIAS: The next phenomenon is known as hindsight bias. What is hindsight bias exactly? Quite simply, it
is the tendency for us humans to view things that have already happened as having been both relatively inevitable
and predictable.
So how does this relate to the world of investing? Well, who among us haven’t at one time or another watched one of
our stocks drop for some reason, and then gone on to lament that we can’t believe we didn’t see that one coming… it

3. was SO OBVIOUS!!! But you see, the problem is that is wasn’t so obvious. It may be now with the benefit of hindsight
but then again, we all know hindsight is 20/20.
And the problem with mistakenly believing that the occurrence was both inevitable and predictable is that we aren’t
then able to adequately learn from the experience. It is important to learn from your errors, rather than simply
attributing your mistake to your inability to notice something at the time that was so very noticeable. The truth is it
never was obvious and your mistake was likely more than simply an oversight.
CONFIRMATION BIAS: Another behavioural bias which can influence our investing is known as confirmation bias.
Confirmation bias is a behavioural flaw of human beings by which once we have made a decision (of any kind), we
tend to actively seek information that will confirm our decision. Without realising it, we emphasise information
which reinforces our view whilst tending to downplay, avoid or even ignore contradictory information.
As an example: Assuming one already believes in the work of a psychic, one will tend to focus on things said by the
psychic that appear to be somewhat accurate whilst overlooking things that are clearly inaccurate. One would do so
simply to reinforce one’s view that psychics are the real deal.
Another more everyday example is when one buys a car and then actively seeks and emphasises information which
confirms the purchase as a good one, whilst ignoring any information that indicates the contrary. Have a think about
it… we all do it, almost every day, in one way or another.
A good anecdotal example of this was seen in the actions of Toll Holdings’ Paul Little prior to the ACCC rejecting his
modified bid for Patrick Corporation in mid January 2006. Despite many conversations with the ACCC, it seems Little
was only hearing the comments which confirmed his belief that the ACCC would not oppose his bid, to the extent that
he had even organised a lunch for institutional investors on the day the bid was opposed! The lunch was abruptly
cancelled and Little was nowhere to be seen or heard for a good day or two as he and his advisors came to grips with
how significantly they had misinterpreted what was actually going on. So it happens to the best of us!
In the world of investing, confirmation bias prevents us from objectively looking at an investment once we have
already made it. Once a stock is bought, we may look for information that confirms the investment as a good one
whilst ignoring information that may indicate the investment is in fact a bad or questionable one.
So how do we combat this? Quite simply, it is important after a decision is made to consider all information you can
get your hands on, whether it is confirming your original view or not. By recognising this, hopefully you will see
when an investment is no longer the right one for you (you will recognise changes as just that and not ignore them)
or when a new investment should be made, even though you have decided against buying in the past. Try to never
fall in love or out of love with a stock; be objective with new information and reconsider the merits of a stock without
looking for information to confirm your current view. Talking to others who have a different perspective can be very
helpful.
COGNITIVE DISSONANCE: The next phenomenon is known as cognitive dissonance. The theory of cognitive
dissonance states that when we hold two conflicting beliefs in our minds, the discomfort caused by this conflict
drives us to acquire, or even invent, new thoughts or beliefs, or even modify current beliefs, in an attempt to relieve
the conflict we feel.
If there is a discrepancy between what one already knows or believes, and new information that comes to hand,
discomfort is felt (dissonance). And in order to relieve this discomfort, we either invent or modify (or rationalise) our
thoughts to eliminate the dissonance that exists.
OK, now for an example, as this can be confusing without one. Suppose you are told by a friend who is a car expert
that you should buy a Holden Commodore ahead of a Ford Falcon, as it is the better car in your friend’s opinion.
However, after having bought the Holden, you come across some new information that persuasively concludes that
the Ford is the better buy. As a result, we have conflicting cognitions in our head, which causes us discomfort, and to
alleviate this discomfort, what we as humans tend to do then is to filter out this new information and seek out
support for our preferred belief. Obviously, once the car purchase has been made, the preferred belief is that your car
is the better one.

4. Clearly, cognitive dissonance is not too dissimilar to confirmation bias. We tend to seek out information that
reinforces our original view, and the basis of why we do this is the classic human fear… the fear of regret. This
phenomenon actually has a name in the world of car and property purchasing… buyer’s remorse.
So cognitive dissonance initiates a form of self-deception, and this occurs in the world of investing too. So often,
investors buy a stock and upon learning subsequent information contrary to their original view, they distort,
manipulate or ignore this new information so as to relieve the discomfort caused by the conflicting views in their
heads.
It remains critical as an investor to constantly re-evaluate positions and views and change them as situations require
and new data becomes available. It is inevitable that investors are going to make mistakes when forecasting the
future. The good investors will minimise the financial damage done by such errors and the poor investors will fail to
minimise the damage and this can lead to a small number of errors causing large losses.
REPRESENTATIVENESS: Representativeness is a human behaviour whereby in order to cope with the myriad
information humans are bombarded with every day, we tend to create stereotypes and patterns with which to
categorise and make sense of information, often falsely. For example, we tend to think of people as either “good” or
“bad” based on a short list of qualities, however in doing so, whilst we may gain speed and simplicity, it is often at the
expense of ignoring the more complex reality of the situation. How often do you “size up” a person in a matter of
seconds? Just about everybody does.
Put another way, humans assume, often incorrectly, that similarity in one aspect leads to similarities in other aspects.
Accordingly, if something doesn’t seem to fit into a known category, we approximate to the nearest category
available. Hence, we often tend to adopt false generalisations without being aware that we are doing so.
This can be seen in the world of gambling. If we toss a coin and get heads five times in a row, we incorrectly assume
that the next toss is more likely to be tails. However, logic tells us that the chance of tails on any toss is the same as
heads… 50%. This is known as gambler’s fallacy. We assume incorrectly because the pattern of alternating coin
tosses sits more comfortably with us... it is more representative. In other words, we expect a random process, such a
tossing a coin, to yield random looking results… we expect the results to be representative of the process that
generated such results. It’s the same way people assume the lottery numbers will be nicely spread out from 1 to 45,
whereas the likelihood of the winning numbers being 1, 2, 3, 4, 5 and 6 is just the same as the likelihood of any
particular set of nicely spread out numbers such as 4, 11, 19, 26, 34 and 41.
In the world of investing, false generalisations are a dime a dozen. We often put stocks in a similar category as others
based on one similarity, when in fact we have by way of a shortcut incorrectly assumed multiple similarities when in
fact there are very few. We also tend to form opinions on stocks based on very limited information. Like with people,
we may view a stock as “good” because the company’s chairman is the chairman of another successful company,
when in fact the chairman may be the only similarity and therefore, categorising these two companies together may
be a big mistake.
Many people will assume that because a company is perhaps well known like Telstra, then it must be a good stock.
This is the process of over simplifying the decision-making process using limited available information instead of
seeking out as much information as possible.
AVAILABILITY BIAS: The next cognitive illusion is known as availability bias. When confronted with a decision,
humans’ thinking is influenced by what is personally relevant, salient, recent or dramatic. Put another way, humans
estimate the probability of an outcome based on how easy that outcome is to imagine.
Consider the following example. In the months after the September 11 terrorist attacks, travellers made the decision
that travelling to their destination by car was a far safer way than by air. In light of the very recent (at the time),
salient and dramatic events of September 11, this decision seemed an obvious and wise one. The probability of
danger when travelling by air seemed much greater than travelling by car… when you think about it, at that time, it
was far easier to imagine something bad happening when travelling by air.
However, this was the availability heuristic at work. The truth of the matter was that firstly, air travel had never been
safer than in the months following September 11, on account of the massively increased security. And secondly, on
account of far more people hitting the roads come holiday time, there were inevitably many more fatal accidents.
Upon examination of the statistics, it was far more dangerous to drive than to fly (US road fatalities in October-

5. December 2001 were well above average) and yet, the availability bias humans suffer from made many feel that
driving was the smarter choice… this decision-making error cost some people their lives.
We also apply this bias in the world of investing. For instance, availability bias can result in our paying more
attention to stocks covered heavily by the media, while the availability of information on a stock influences our
tendency to invest in a stock. The dot.com boom of 1999/2000 is a great example. The availability of information and
media coverage of internet stocks was such that people were more inclined to invest in them than they would have
otherwise been.
Be wary of following the latest market fad simply because of the availability of information. If you have read it in the
newspaper, you may well be amongst the last in the market to know!!
HERDING: The next phenomenon is known as herding. Evolution has equipped humans with a tendency to herd, or
stick with the majority. Presumably, this would have served us well in days gone by, but in the world of investing, it
can be very treacherous.
Following the crowd has always made people comfortable, and being the odd one out leaves most feeling uneasy. We
are programmed to feel that the consensus view must be the correct one and this mistaken belief that not everyone
can be wrong has led to many a disastrous decision. Following the crowd can cause investors to follow various
fashionable investments simply because others are doing so.
The dot.com boom of 1999/2000 is an excellent example if this, where many investors who were initially sceptical
ended up buying into the hype under the mistaken belief that not everyone could be wrong. And yet, most people
were wrong.
On a final note, it is preferable to be in the minority and not blindly following the crowd. Bear in mind that more
people fail in the market than succeed, as is the case with many endeavours (sport for example). Unfortunately,
excellence is the exception rather than the rule and we should aspire to be unique and not just part of the herd. And
remember that the consensus view isn’t necessarily the right view.
SELF ATTRIBUTION BIAS: Another phenomenon is known as self-attribution bias, which is the tendency of humans
to attribute successful outcomes to our skill and to attribute unsuccessful outcomes simply to bad luck. There isn’t a
great deal to say on this topic, as its relevance to investing is largely self-explanatory.
Investors who experience a run of successful results start to develop an inflated opinion of their own skill, thus
possibly resulting in both complacency and exaggerated risk taking. And of course, if one endures a horrendous run
in the market, by attributing this simply to misfortune, how is one to successfully learn from one’s mistakes?
Take care not to fall into this trap. Try and learn from your unsuccessful outcomes and when success comes your
way, do not let overconfidence step in and prevent you from acquiring a realistic assessment of your own talents.