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This episode aired on Bloomberg TV on May 31, 2013

Availability Bias

Q. So this is another important behavioral finance concept that trips investors up a lot…

A. It sure is. We’re wired with a lot of mental shortcuts which worked well out on the Savannah but not so well in the stock market. A big one is availability bias… basically, the idea is that the easier something is to recall, the more important it seems. It’s related to recentcy bias– since what we’ve just witnessed is very easy to remember.

Q. So a quick examples?

A. A classic one is this: are there more English words with “K” as the first letter, or “K” as the third letter? Think about it for a second.

Q. Uh… easy to think of ones that start with K: keep, kale, key…

A. Right, but actually there are twice as many where K is the third letter… they’re just hard to think of so we underestimate the number of them. That’s availability bias. And so we currently have baked into our brains a rising stock market, and super low interest rates…

Q. So investors are likely to overestimate the chances of those going forward…

A. Right, and its even more specific than that. People will pay a lot more attention to analyst upgrades now, because it’s consistent with their current experience. They’ll do the same for downgrades when the market is falling. But probably the most serious consequence of availability bias is return chasing… we’ll look at very recent manager results and jump on the bandwagon.

Q. And even though all the disclaimers say “past performance is no indication of future results” investors tend to ignore that…

A. Right. It’s probably the only statement that’s true in every single prospectus in which it’s appeared. Especially with all the simultaneously occurring unprecedented factors– all the QE, a 30 year bull market in bonds– people have to try hard to overcome availability bias and take into account that the future is likely to be quite different than the present. It’s hard, but worth the effort!