With the holiday season swinging into full gear, holiday parties with friends, family, and co-workers are likely on the horizon. Often, these parties are a great time to catch up in a laid-back environment and socialize about things that are less work related. However, as the drinks begin to flow and the night progresses, conversation can often turn toward that of stocks and investing.  Naturally, the first item of conversation would be mentioning what a great service 5i Research offers at a low cost and how your friend/family/co-workers can join or purchase a gift membership for conflict-free investment research! But after that, these conversations usually devolve into a competition of who had the greatest stock picks of the year. While these can be fun conversations to have, be aware of some common biases others may be using in these conversations and try not to use them yourself:

1.     Hindsight bias – Ever had a conversation that goes something like this: “How didn’t they see it coming back in 2008!? I mean, people could clearly not afford those houses and housing prices were in bubble territory, all you had to do was look at a chart to see it”. If you have, you have likely been in a conversation involving hindsight bias. This is a classic bias where individuals see past events as predictable, simply because the outcomes that occur are more evident and the dots are easier to connect.  Past events can play out in an uncountable number of ways, just because it happened a certain way does not mean it was at all predictable at the time.

2.     Self-attribution bias – We are all guilty of this one and investment professionals are perhaps the largest perpetrators. Self-attribution involves taking credit for positive outcomes and blaming negative outcomes on factors out of one’s control. A typical example would be an investor saying they had performed a diligent analysis and found an undervaluation in a positive performing investment yet blaming another poor performing investment on a bad market or investor irrationality.

3.     Loss aversion/disposition effect – Loss aversion is an emotional bias where investors prefer avoiding losses to achieving gains. Losses hurt more; it is no secret. Loss aversion feeds into the disposition effect, which is a tendency to hold onto losers and sell winners. This is a common approach we see amongst investors. Investors are quick to sell a winner even though the outlook and prospects of a stock at a higher price may be better than it was before. Consequently, investors like to hold onto losers even after something fundamental has changed at a company for the worse.  This bias can come up in conversation when we brag about ‘locking-in’ a profit on an investment that has performed well. Alternatively, there may be talk of ‘a stock that is so low compared to a few months ago that it could only go up from here’.

It can be fun talking about investing and learning from peers but it is important to be aware of some major biases that others may be unknowingly committing. It is also helpful to be careful to not commit them yourself and become ‘that guy’ at the holiday work function.  More important than anything however, is to ensure that you have a safe and happy holiday and travel safely and responsibly!

Happy holidays from 5i Research.