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Chapter 2. Behavioral Finance > Your Psychological Biases

Your Psychological Biases

People are designed to think they are better off than they really are. In addition, we seek information that confirms this belief. Our ongoing self-deception leads to decision errors. We become too confident that our opinion is correct, and we place too much value on our previous decisions. For example, people are prone to attribute past investment success to their skill at investing. This leads to the psychological bias of overconfidence.

Specifically, people believe their knowledge is more accurate than it really is and that their forecasts are more precise than their experience should validate. Because people are overconfident about their decisions, they turn out to be wrong more often than expected. One would think that a rational learning process would eliminate overconfidence over time. We should learn from our mistakes. However, nature seems to provide us with a biased learning process that attributes good outcomes to our own abilities and bad outcomes to external circumstances. This learning process must be acquired at an early age, because nothing bad that happens to my children ever seems to be their fault (according to them, anyway!). This self-deception fosters overconfidence.


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