EP54 (Part 3) Emotional Errors Behavioral Biases
This is volume vesting. I'm your host, June. Kim in this podcast. You'll learn everything related to volume best. Hello, follow investors. Welcome to another episode of volume vesting podcast over the last two episodes. We talked about cognitive airs stemming from belief perseverance and information processing airs on today's show. I wanna talk about another important biases which are coming from emotional airs. So it's going to be very interesting topic, so stick around, and before I get started. Let me just give you kick. Disclaimer as always that this podcast is for entertainment purposes, only, and it is your responsibility to consult with your investment professional for any investment decisions. So we offer the delay water we get started. So as I mention in the loss to be, so it's we talked about college airs the first episode we talked about conservatism bias confirmation bias illusion of control representativeness bias in hindsight bias. And in the Las episode, we talked about anchoring bias, mental accounting framing bias and availability bias. So if you haven't got a chance to listen to these two sorts, I highly recommend you go back and listen to these two episodes, I and come here, but this episode is going to be independent of these two other episodes. So if you just like to stick around and just listen to this episode it's also fine. So as mission, I want to talk about emotional biases, and these are biases that are really hard to correct. If you know they exist of this biases. So in-depth sense is different from cognitive errors because, as I mentioned in the last episodes, colony heirs are relatively easy to be corrected once, you know, the existence of those biases, but emotional biases are something that it's very hard to correct. Even if you know, so let's go over them and see. So why it is the case. So what I like to talk about is six different emotional biases today loss, aversion bias, overconfidence bias, self control bias endowment bias regret aversion bias status co bias. So these are the six emotional biases that I like to talk about on today's show since we have a lot of materials to cover. Why don't we just dive into materials? The first one that I like to talk about his loss of version bias. So what is it? Loss, aversion refers to people's tendency to prefer avoiding losses to acquiring equivalent gains loss version implies that one who loses one hundred dollars will lose more satisfaction than on the person real gain satisfaction from one hundred dollars windfall. So you probably have this tendency. I definitely have this ten Tennessee as well. So whenever you are investing in the stock market. Even if you have some losing positions, you probably hold onto that position in the hopes of breaking even at some point in the future. But the problem is that if you tend to hold onto losing positions. There is a great probability that deposition would lose more money in the future. And what's more at risk? Is that you are, incurring opportunity costs as a result of holding onto that position because you have your capital strapped to that position and you cannot utilize capital. More efficient manner. Also want to say that loss aversion is not always the bad thing for investing. So let me just see how you can use loss, aversion in some cases, to your advantage. I if you have huge loss, aversion, you can invest insecurities, only when the odds are stacked hugely in your favor. In other words, when you have very large margin of safety, so you're. Our main goal is not to lose money. And in order to do that you own the invest your money into securities, whenever you have large margin of safety. So that's actually upside of having this loss aversion and use that to your advantage. And also, you can pass up a lot of investment opportunities, if you feel that they're not falling into your circle of confidence, and you can actually be successful even after having huge loss, aversion effect. And Lastly, I think I also wanna mention that you, can, you know, try to avoid any leverage, because once you leverage, your perform, your gain is going to be huge if things actually go in the right direction. But if things go in the wrong direction, then you'll loss is going to be also huge. So it's always symmetrical. So you have to watch out for any potential catastrophic losses again here. If you have large loss aversion than at this is something that you can use to your advantage by avoiding any leverage that is not necessary. And also tried to always have large margin of safety, whenever you buy into certain positions. So. So that's just my piece of advice. So that was loss aversion. Let's move onto the next bias. The next bias is overconfidence bias. So people tend to be overconfident in their judgment. And a study shows that eight out of ten people think that they are above average drivers, which is obviously not true. It doesn't make sense, but people have tendency to think that their skill sets are better than others. And also, let me just give you another example, a person who thinks he's invaluable to his or her employer when almost anyone could actually do. He's or her job. If that's the case, Dan debt person. My show, he's or her overconfidence by coming in late to work because this person thinks that he can not get fired and also like can be overly demanding about getting a raise and so on and nobody likes that kind of person. So this person is going to be at risk of being laid off at some point in the future, if he or she persists acting this way. So that's part of overconfidence bias. When it comes to investing people tend to think that they can beat the market, I including me, whenever you actually manage your money by yourself. That means you think that you can be the market. If you really think. That you can beat the market you want to make an assessment about yourself. What are your strengths what sets you apart from other people and what makes you think that you can beat the market? What makes you so special? Those are the type of cash is that you have to ask yourself in order to make of Jack assessment about whether or not, you can be the market. Also some people believed that they develop a special formula decking us to beat the market, and they really stick with that. And as probably, you know, I don't think that formula approach is going to work out. Well over a long period of time, because let's say you develop very special formula that could actually bring you very high rate of return, then deaf Omolo is going to be discovered by other people, and it's not gonna be useful anymore after certain time period. So that's why all Miller based approach. Is not probably a good idea, as far as investing is concern. But if you have that believe, and if you are overconfident about your -bility to use these formula, then you falling into trap of overconfidence bias, let's look at another example when it comes to investing. So people overlook the risks associated with specific stocks and assigned, the probability of losing money in stock incorrectly. So what can we do in order to avoid overconfidence? The first thing that you have to do is be humble of meat that we can all be wrong, anytime and seek out opposing views and be open to listening to other people because if you buy into one stock, then you probably have strong conviction that you're gonna make money here. But just take a look at, you know, short side of the story in opposing views. And try to understand if they have any married of proposing those ideas. And on thing that I also wanna mention is that don't concentrate too much in one specific. Stop you always have to strike a balance between the number of stocks that you hold and the return that you're gonna get. And if you believe that you have very high level of confidence in one stock. Then you can actually increase the stake in specific stop. But you may want to have some system where you don't invest. I don't know maybe more than twenty percent of your total portfolio. Diversification actually is very subjective. Concept, some people think that twenty percent of investment is, you know, well diversified all the people think that this is so concentrated. So it all depends on your situation. But rule of thumb is that you probably need six stocks at the minimum that are in completely different industries. So if you own six financial institutions that doesn't mean that you are doing the diversification. Because they are all in the same industry. So you want to have at least six different stocks in completely different industry, and that probably real provides some diversification effect. But if you want to invest in individual stocks and own laissez one hundred stocks, then you kind of lose sight of, like what the are, and what these companies are doing. So there's always a balance between the number of stocks that you own concentration versus diversification. Because if you diversify your performance too much, then you probably get rid of all, these eaters, credit risks, but you probably going to get just market return, which means you better off just buying index fund. So think about the balance, always everything is balancing live. So that's what I want to say here. So that's about overconfidence, and everyone is exposed to this bias including me. So let's just watch out for not getting into this trap, the next bias that I like to talk about today is self control bias. So this is human behavioral tendency that causes people to fail to act in pursuit of their long term overarching goals because of lack of self discipline. Many people are notorious for these plane, a lack of self control when it comes to money. So let me just give you some examples. Self control bias can cause investors to spend more today at the expense of saving for tomorrow in may cause investors to fail to plan for retirement. So this is a good example of self control bias. And this is not easy to control. Right. So it is very similar to losing weight. So people know exactly what they need to do to lose weight. There's only two things you need to do. Eat less exercise more. It's very simple, but it's not easy to execute. It's basically the same. So there's this like self control bias, so people have their money right now in their pocket, and they want to spend their money right now. They know that they if they invest this money in the stock market, or if they put this money in high ill savings account, then they can have more money in the future. But that's not what people really think in how they react, they have tendency to spend more money today, the expense of saving money for tomorrow. So that's self control bias. As far as investing is concern idea. Lot of investors. Check stock price too often. That's just my view and they know that it's not gonna really yield anything for them, and it's not going to result in any gains for them, but as they can't help but shaking stop price, every day even if they perceived himself to be alone or investor. And also, it's probably going to prevent you from becoming a longer investor, because as you check, stop prices, too often you're gonna get more influenced by Mr. market, and that's really not good for your mental health and physical health either. I don't know how to overcome this self control bias because, as I mentioned, this is similar to losing weight at there's just a lot of people who want to lose weight, but they can because they're electing self-discipline, or I mean there might be some of the issues that I'm not aware of, and it's just not easy because it requires a huge self-discipline for yourself and it's basically the same for investing. So regarding investing, you need to have, right. Temperament, that's what Warren Buffett has mentioned in the past, and right, temperament means that you need to be patient, and you need to control yourself, you shouldn't be stupid. When it comes to selling your stocks and buying stocks. What I mean by that is don't sell your stocks went stock crashes and don't buy stocks, when everyone is jumping onto the bandwagon. And those are the things that you have to always keep in mind. Because it's easy to fall into his traps. Why anyway, so that's about self control bias. I like to give some advice related to this feel, but as I mentioned, this is very simple. But not easy to execute. So I'll leave it up to you. The next bias is endowment bias, endowment bias describes a circumstance in which an individual values something already own more than something. They don't own yet investors, therefore and to stick with certain assets because of familiarity and confer, even if they are in appropriate or become unprofitable. Okay. So that's the definition of Dom bias, simply is basically saying that you volume wide, you have a lot more than what you don't have. So let me just give you an example. So there are two experiments on that. I like to talk about the first experiment is called the mouth experiment. So this study shows endowment fact, and scientists randomly divided participants into buyers and sellers and gave the sellers coffee mugs as a gift. They then asked the sellers for how much they would sell the mug and asked the buyers for how much they would buy the results showed that the sellers who already owned the monks placed a significantly higher value on the monks. Then the buyer stood there were willing to sell a mug for seven dollars. Approximately. While buyers were willing to pay approximately three dollars. So there's a huge difference between how sellers price the monk versus buyers because sellers already have these monks in their hands. So they volume LA more this in domino. Effect on other experiment is cold. The basketball team gets experiment. And here Duke University, conducts a lottery between fans that one tickets because there's not enough space for everyone after one of the lottery's occurred, the researchers called an ask that we nurse who got the tickets how much they would sell the tickets for then they called an ask the losers how much they would buy for the results revealed that the selling price point was almost fourteen times more than the buying won the lottery winners wanted. Two thousand four hundred dollars on average to give up their tickets. While the lottery losers. Who did not have the tickets were willing to buy them for only one hundred seventy five dollars. So this is quite interesting. The moment the lottery winners got their tickets. They volume to a higher degree and giving them up become much hotter. Right. That's kind of the opposite for lottery losers. So this is not a rational from any perspective. What about investing? So when it comes to investing, you could volume the stocks, you'll let you own a lot more than other stocks available out there. So this is problematic. If you have high opportunity costs, which is not investing in those other stocks. So you have to have objective views about why you'll let letting having performed yo versus while you don't have, you know, the performance you have to make us s in terms of how much level of confidence you have stocks in within your performance versus others. Make us -ment in terms of circle of confidence all these concepts, but all things equal you. You probably want to get rid of in dominant fact, by having objective use D other thing that you probably gonna go through. Is that once you buy a house, you leave there for no more than five years, and you attached to their house, and you have strong bonding with your house? And you want to maybe sell your house at some point in the future. What's going to happen? Is that in Dominy fag, it's going to take it back? And you may put your house off for sale at a price a lot higher than the market value because you think that it is really valuable because it's your own house. It's your own baby. But the Marquette participants or buyers potential buyers that think that way, they have a lot of auctions. So if this house is not sold for certain time period than you probably end up. Selling it at our low price because people think that there's something wrong with the house, and if it's not sold. Within certain time period. And if the house is listed for more than thirty days than people would lose interest of even looking at your house, so you probably will lose a lot more money if you don't actually price your house in L objective manner. So anyway, so that those are the examples that I can think of related to endowment bias. So let's move onto the next bias, next bias is called regret aversion regret theory states that people anticipate regret if they make a wrong choice, and they take this anticipation into consideration when making decisions fear of regret can play a significant role in dissuading someone from taking an action or motivating a person to take an action. So as far as investing is concern regret. Theory. Regret bias can either make invest. Easters risk averse or it can motivate them to take greater risks. So Limoges provide some examples for urine, the standing suppose that an investor buys a stock in a small growth company, based only on of France. Personal recommendation after six months, the stock falls to fifty percent of the purchase price. So the investor sales the stock and realizes a loss to avoid this regret in the future. The investor will ask cushions and research any stocks that he's friend recommends conversely, supposed investor didn't take the France recommendation to buy the stock, and the price increased by fifty percent to avoid the regret of missing out the investor will be less risk averse this time and we'll likely by any stocks that he's friend recommends in the future. Without conducting any background research of his own. So this is regret aversion example. And I think that this happens all the time and be no our motions, and even if he knew then sometimes we can help, but falling to this kind of trap. So another regret reversion case is that people really think that this is actually combined loss aversion, and people don't want to lose money as a result of that they avoid investing in stock market altogether. And I think that's a huge opportunity cost because over the long term stock market has produced six to eight percent return. And if you look at all their asset classes than you cannot find other classes like that other than a real estate's. So if you just invest based on your feeling STAN, it's a huge mistake. But if you can locate your capital as spread them out over a long period, and keep investing, regardless of market fluctuations. Consistently over time. I think you're gonna fine by investing your money in index fund, like SMP five under it a low cost index fund. But because of risk aversion a lot of people avoid the stock market and real buying a house altogether. And I think that's a mistake. Anyway. So let's move onto the loss biased for today's show, which is state us co bias status co bias is something that involves people preferring that things stay as they are, or that the current state of affairs, remains the same change can be a scary thing for a lot of people. I know this is the case, and even though it's probably going to cost them a log people try to stay where they are, and try not to change. So let me just give you creek examples of this status quo bias, a lot of people tend to stay in the current position, even if all their good opportunities arise, and also, they tend to, you know, leaving the same place and they try not to move to different places. And if you look at food, you probably tend to go to the same restaurants as before, and try not to experiment, you food. And so. On so these other status quo bias and also related to staying within your comfort zone. And if you wanna get out of comfort zone than it requires some more energy, and it gives you some stress and that's why people tend to stay where they are. But as you know, if you stay where you are for more than certain period, time when he comes to say your job, you're not learning you need to have some steep learning curve in order to improve yourself in your current job position. And if you just do exactly what you have done in the past, then you're not gonna you'd probably going to be an expert in that area, but you're not gonna learn anything you and you're gonna probably fall behind compared to the people. So if you wanna get ahead of the people, and you oughta make yourself per doubt the and you wanna be more competitive than you have to force yourself out of your comfort zone, and you don't go and do something else when it comes to jobs, and meeting new people trying new food. Food and go to different places, and especially if you're young, then you have to do all these things before you are established in one place. Anyway. So let's go to investing area and see what we have to do. So when it comes to investing people tend to stay with their current per folio, and actually this is not necessarily bad. Even though this is that a cool bias, you probably want to be a long term investor, and you can hold onto your current positions to become a long term investor. If you believe their fundamentals are still intact and only my strategy is only trade. My stocks are when fundamentals are actually different from my initial assessment, and deteriorates over time or if the market is self is very, very overvalue. So there's always opportunity costs associated with staking with your current portfolio. So it's always practicing a balance between becoming a long term investor and switching to different stocks. And that's always something that you have to think about an always have to take into consideration when it comes to investing your money. So there's no one solution that you always have to stick with. But always think about all these things and put it into consideration. And that's something that we all always have to worry about anyway. So those are the things that I wanted to go through on today's show. So let me just quickly COO over what we have this today. We talked to buy motions vices six emotional biases loss, aversion bias, overconfidence virus self control bias endowment bias regret aversion bias status co. Bias? So these six emotional biases, we discussed and as I mentioned, many times, emotional biases are not something that you can easily. Correct. So it's better to be aware all existence of these biases. But also think about what is the best way for you to overcome these biases and I can provide some advice, but it's all up to you, because each individual is different when it comes to handling their emotions. Some people can quit smoking, or drinking quite easily whereas other peoples cannot so because they have different this planet, there, they have different temperament, so there's no one specific solution that can fit into everyone's problems. So that's why I think it's important for you to be aware of this biases and try to explore the furnace Lucians that actually are suitable for your case anyway. I hope you enjoy this podcast and learn something out of this episode, and that's it. So if you haven't already done, so please leave your rating, or comments on whichever platform, you listen to this podcast is podcast is basically broadcast on many different platforms including items, Android phone apps, and so on. So I'll try to read them, and if you also want to listen is podcast from my homepage. I'm gonna leave link there in the show so that you can just go there and check it out. Thank you very much. And see you next time.