Availability Bias in Behavioural Investing

All of us have seen movies or have read novels wherein there are several witnesses who are describing the same crime scene.

However, each of them describes the scene in different ways. This is because their experiences are colored with their own thought processes.

This makes different people look at the same situation in different ways. This is also the case with investing.

Based on the previous experience that an investor has had, investors might view different situations differently. Behavioral finance practitioners are aware of this investor tendency. The details of this behavior have been explained in availability bias.

In this article, we will have a closer look at what the availability bias is as well as how it can impact decision making.

What is the Availability Bias?

Availability bias refers to the tendency of investors to extrapolate their personal trends and consider them to be the market reality. For instance, the business of a certain person may be profitable even during a recession.

Hence, they are likely to assume that even if the recession continues, the market will continue to rise further.

On the other hand, if a person has suffered a job loss in a growing economy, he/she is likely to believe that the entire economy is headed downwards.

Availability bias is called the availability bias because it depends upon the user being able to recall their experiences. The experiences which are most vivid or deeply experienced are the ones most readily available for decision making. This is the reason that this bias is called the “availability bias.”

Availability bias is the reason that an investor who may have lost money in the share markets starts to believe that the markets are excessively risky and hence avoids investing in them.

Availability bias basically explains how the beliefs of an investor can become excessively influenced by their experiences and hence can go completely out of sync with reality.

Types of Incidents Which Impact Availability Bias?

All incidents do not impact availability bias in a similar manner. Over the years, psychologists have studied and realized that there are some types of incidents that are more likely to be recalled. Some characteristics of such incidents are as follows:

• Incidents which happen more frequently are more likely to be recalled

• Incidents which are unusual or extreme in some way are more likely to be recalled

• Negative incidents are recalled more easily than positive incidents (loss aversion)

• Recent incidents are recalled more easily than incidents which have happened in the past

How Does Availability Bias Affect Investors?

Availability bias negatively affects the interests of investors. Some of these negative effects have been listed below:

• As a result of availability bias, investors are often caught mitigating the wrong risk. This is because the perception of the investor depends upon their own life experiences, which are unpredictable.

  Also, investing with availability bias is like looking in the rearview mirror. People with availability bias are looking at the most recent risks.

  For instance, investors with availability bias in 2010 were trying to avoid mortgage-backed securities. The reality was that the fiasco in mortgage-backed securities was already over.

  The next market bubble would most likely come from a different type of security. Investors with availability bias would be too concerned about mortgages since they would have lost money due to mortgages the last time. They would not be paying attention to equity, debt, or other kinds of derivatives, which could become the reason for the next downfall.

• Investors with availability bias are more likely to invest more in companies that they regularly hear about. They are unlikely to select the best stocks because of investment rationale.

  Instead, they are likely to have an inclination towards making investments in companies that are present in the news. This creates the wrong incentive for companies.

  There are several companies that pay media outlets to cover their stories more extensively. This helps them create a recall with the investors.

  Hence, when investors are pitched with an investment for such a company, they are more likely to make this investment decision.

• Investors with availability bias are more likely to overreact to market news. For instance, these are the investors who create volatility in the market after an unexpected earnings announcement. These investors also trade excessively when there is news of a product recall by the company.

  A small product recall might not have a large financial impact on the financials of the company.

  However, investors with availability bias get carried away with all the negative publicity in the news. This is the reason that they tend to overreact. More often than not, this has a detrimental impact on their portfolio.

How to Avoid the Availability Bias?

Availability bias generally impacts people who track their investments too much. While it is good to keep an eye on the behavior of your investments, it is wrong to obsessively track their every moment.

The more a person pays attention to their investments, the more likely they are to make a premature and wrong decision.

The best defense against availability bias is to filter the news that we hear about our investments and act on them in a rational manner.