What Is A Cognitive Bias?

    Have you ever wondered why you can be so perceptive when it comes to other people’s issues and so hapless when it comes to your own? The answer may be that you have a cognitive bias. If so, don’t blame yourself. It’s not your fault. It is the way human brains are wired.

    Cognitive biases are psychological tendencies that cause the human brain to draw incorrect conclusions. Such biases are thought to be a form of a “cognitive shortcut,” often based upon rules of thumb.  They include errors in statistical judgment, social attribution, and memory. These biases are a common outcome of human thought, and often drastically skew the reliability of anecdotal and legal evidence.
    These tendencies are particularly persuasive when it comes to dealing with money and investments. Put simply, such biases can lead even the most sophisticated investors into making regrettable decisions. Here are some examples of common decision-making biases:
• Confirmation bias: a tendency for people to favor information that confirms their preconceptions — regardless of whether the information is true.
• Outcome bias: a tendency to judge a decision by its eventual outcome instead of based on the quality of the decision at the time it was made.
• Choice-supportive bias: a tendency to remember one’s choices as better than they actually were.

Former Chairman of the Federal Reserve from 1987 to 2006, Alan Greenspan, made another cognitive bias memorable when he described investors in the 1996 stock market as behaving with “irrational exuberance.” In other words, investors were bidding the price of some stocks much higher than they were actually worth, and therefore taking risks that were inappropriate in light of their goals.
    As investors, errors in judgment are often the direct result of our cognitive biases. That is where an experienced investment advisor can prove invaluable. By understanding the behavior behind personal investment decisions, they can help you avoid the irrational thinking that can cost you dearly in the long term.
    For 26 of the most studied and widely accepted biases, visit http://en.wikipedia.org/wiki/list_of_cognitive_biases.