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Behavioral biases are not restricted to any particular wealth level. People are people.
In Episode 10 of the Mindful Wealth Podcast we hosted Michael Pompian, the author of 5 books on behavioral finance including his latest book focused on the individual investor, Behavioral Finance and Your Portfolio.
After decades in the private banking and wealth management spaces working with both mass affluent and with ultra affluent family office clients, Michael wants to be sure we all understand that people are people – behavioral biases are not restricted to any particular wealth level.
The neo-classical economics that was taught in the early 20th century had an idea of human beings at its heart that doesn’t really square with reality. Homo-economicus is the label for the consumer as rational optimizer. The assumption in classical economics was that humans are perfectly rational, perfectly self-interested, and have complete information before they make decisions to maximize their “utility.”
In the past couple decades, starting with Kahneman’s Nobel Prize for “Prospect Theory” – the idea that the pain of loss is 2X the joy of a similar gain – Behavioral finance has come into its own. The goal for humans, maximizing utility, remains the same… but the ideas of perfect rationality, perfect self-interest, and complete information are tossed out the window.
The reality is that humans are NOT perfectly rational, nor do they have complete information before making decisions, and usually they can’t even tell you what they are trying to accomplish with the decisions they make.
Being human involves a host of cognitive and emotional biases.
Cognitive biases can be split into Belief Perseverance Biases like confirmation bias and Information Processing Biases like recency bias or mental accounting. These can be overcome (a little) by education and better systems.
Emotional biases like Kahneman’s “Loss-Aversion” are much more difficult to overcome because they involve an individuals feelings and are often the uncontrollable knee-jerk reactions we have to outside stimuli.
Michael’s latest book, Behavioral Finance and Your Portfolio introduces 4 different investor types and aligns the types with their most prevalent biases.