Question

Discuss types of biases that result in investors making active choices that are less than optimal.

In contrast to the biases discussed in the previous question, certain types of biases can yield less than optimal choices by individuals.

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Answer 1

The various types of investment biases faced by an investor are as follows:

• Confirmation Bias - This is also known as the First Information Bias. Here the investor already makes a decision based on the first impression and only accumulates facts that support his initial opinion.

• Familiarity Bias - Here the investor wants to stay in a known territory for the sake of comfort despite knowing that diversified ventures will lead to better return in the future.
• Trend Bias - The investor here is only concerned about past data and past performance and does not bother about the future of the company. This can work well with well diversified conglomerates but with medium sized firms, this approach often fails.   
• Hindsight Bias - The investor here tries to reason with the past movements in the stock and makes false assumptions or draws wrongful conclusions as to what factors caused the movement in stock prices and invests based on such erroneous knowledge. This is very risky and leads to losses more often than not.