After years of low and declining volatility, investors have had some adjustments to make in the last six months or so. Volatile markets, especially falling ones, can play tricks on the mind. None of us are immune to the various behavioral biases that have spawned the now popular field of behavioral finance. Being aware of those biases should help, however, and I recently decided to review the literature to be better protected from my own rationality. As a guide, I used Behavioral Finance and Wealth Management by Michael M. Pompian, which I would recommend as an introduction to the field.
Out of the 20 biases Pompian discusses, I have singled out 8 which I consider most relevant at this time. In order to keep my blog posts within reasonable length, I will divide these into two sections. The biases are separated into emotional biases and cognitive biases. This post will deal with emotional biases and the next one with cognitive biases. I am not making any specific recommendations, but merely reminding you to be aware of these common pitfalls. Read the rest of this entry »