The Ultimate List of Cognitive Biases

The Ultimate List of Cognitive Biases by John Szramiak was originally published on Vintage Value Investing
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The Cognitive Bias Codex - Vintage Value Investing
via Better Humans (click image to enlarge)

Our brains are incredible things.

Every minute of every day our minds absorb tremendous amounts of new information.

Some of this information we consciously think about, question, work on, mull over, and attempt to solve.

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However, the conscious part of our brain can only focus on one thing at a time. To make matters more complicated, we often have to think and act quickly.

So, our brains will often use shortcuts to help us out. These shortcuts are called heuristics.

These mental shortcuts are incredibly useful and they’re often very accurate. That’s why our brains evolved to use them in the first place.

Unfortunately for us, heuristics aren’t infallible. Sometimes things aren’t exactly as they appear on the surface (for example, a common situation has been slightly changed or is unique). In these instances, relying on heuristics can seriously hurt us and cause us to make bad decisions.

When our heuristics fail to produce a correct judgment, the result is a cognitive bias – which is the tendency to drawn an incorrect conclusion in a certain circumstance based on cognitive factors.

Cognitive biases can affect us in all aspects of life, from shopping to relationships, from jury verdicts to job interviews. Cognitive biases are especially important for investors, whose main goal should be to think as rationally and logically as possible in order to find the true value of a business.

Therefore, an awareness of the heuristics your brain uses and the cognitive biases they can cause is imperative if you want to be a successful investor.

As the father of value investing Benjamin Graham noted in The Intelligent Investor:

If you’ve read Thinking, Fast and Slow by Daniel Kahneman (a book I highly recommend), then you probably already know some of the most important heuristics and cognitive biases that affect us nearly every day – and, importantly, that affect investors when we make capital allocation decisions.

However, there are dozens and dozens of different heuristics and cognitive biases that our brains can use. Wikipedia’s list of cognitive biases lists 175 different ones. That’s a lot of biases to be aware of.

Luckily, the list of cognitive biases becomes much easier to deal with if we can condense them into just several broad groups. Buster Benson over at Better Humans came up with four categories for the 175 possible heuristics and cognitive biases based on the problems that they help our brains solve.

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The 4 Problems Heuristics Help us Solve

As Buster points out, every heuristic exists for a reason – primarily to save our brains time or energy. When we look at them based on the main problems that they’re trying to solve, it becomes a lot easier to understand why they exist, how they’re useful, and what mental errors (cognitive biases) they can introduce.

The four main problems heuristics help us solve are:

  • Information overload
  • Lack of meaning
  • The need to act fast
  • How to know what needs to be remembered for later

Problem 1: Too Much Information

Because there is just too much information in the world, our brains have not choice but to filter most of it out. Our brains use a few simple tricks to pick out the bits of information that are most likely going to be useful to us in some way.

Problem 2: Not Enough Meaning

The world is very confusing. Even once we reduce the amount of information we process through the heuristics and cognitive biases above, we still can’t always understand it easily. So, our minds connect the dots and fill in the gaps with what we think we already know.

Problem 3: The Need to Act Fast

After we reduce the stream of information we process and then make assumptions about the data, we then have to work quickly to act on it.

Problem 4: What Should We Remember?

With so much information presented to us all the time and a limited amount of memory to store it all, even after we reduce the data stream, fill in the gaps, and act on it, we must finally choose what is important for us to remember and what we can safely forget.

How to Combat the Negative Effects of Heuristics and Cognitive Biases

We are faced with too much information, so we filter out the unimportant things. Once we have reduced the stream of information to only what is the most useful to us, we create meaning by filling in the gaps of what we don’t know. Then we need to act fast, so we jump to conclusions. Finally, once all is said and done, we try to remember only the most important and useful bits.

Remember, heuristics aren’t inherently bad. They are actually quite useful to us 95% of the time because they solve those four problems mentioned above – information overload, lack of meaning, the need to act fast, and the decision about what to remember. Without them, we wouldn’t be able to effectively move through life.

But you need to be aware of the downsides that these heuristics and cognitive biases can cause the other 5% of the time.

You need to detach yourself from whatever situation you’re in and be aware of how your mind is thinking – not just what it is thinking. This is especially important when you’re investing.

So, keep in mind at all times that the four problems that heuristics solve create the following secondary problems:

  • We don’t always see everythingJust like a sieve lets some precious stones fall through the cracks, sometimes the information we filter out is actually useful and important to us.
  • Sometimes the conclusions our minds immediately jump to don’t reflect what’s actually trueJust like an optical illusion can cause us to see shapes, lines, and colors that aren’t actually there, our heuristics and biases can result in cognitive illusions by causing us to construct stories and imagine details that aren’t actually true.
  • Quick decisions can be the wrong decisions. We all have gut instincts and things we feel are true. If these instincts are misinformed because of a cognitive bias, then our actions can be the wrong actions.
  • Most people don’t have photographic memories. Our memories are partly based on reality and party based on the action of remembering itself. These memories then inform the cognitive biases in the other 3 groups above, creating a self-reinforcing cycle.

You don’t need to memorize every single heuristic or cognitive bias.

But you do need to be aware of them, which means you need to be familiar with them and at least know that they exist. You can become more familiar with them by reviewing the list of cognitive biases above. Keeping them organized based on the four problems Buster Benson identified should certainly help as well.

Or you can check out the Cognitive Bias Codex graphic below. If you want, print it out and hang it up somewhere where you’ll see it all the time… or even set it as your desktop wallpaper!

The Cognitive Bias Codex - Vintage Value Investing
via Better Humans (click image to enlarge)

If you want to learn more about heuristics and cognitive biases, check out 6 Cognitive Biases, Heuristics, and Illusions That Daniel Kahneman Thinks Investors Should Know and Nine Cognitive Biases You Need to Understand to Master Your Money.

Or even better yet, read through the 3 books listed below.

Finally, don’t forget that this post is sponsored by Audible. Get your 30-day free trial here or sign up for a Gold membership here. Your support helps keep Vintage Value Investing ad-free! ?

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Ben Graham, the father of value investing, wasn’t born in this century. Nor was he born in the last century. Benjamin Graham – born Benjamin Grossbaum – was born in London, England in 1894. He published the value investing bible Security Analysis in 1934, which was followed by the value investing New Testament The Intelligent Investor in 1949. Warren Buffett, the value investing messiah and Graham’s most famous and successful disciple, was born in 1930 and attended Graham’s classes at Columbia in 1950-51. And the not-so-prodigal son Charlie Munger even has Warren beat by six years – he was born in 1924. I’m not trying to give a history lesson here, but I find these dates very interesting. Value investing is an old strategy. It’s been around for a long time, long before the Capital Asset Pricing Model, long before the Black-Scholes Model, long before CLO’s, long before the founders of today’s hottest high-tech IPOs were even born. And yet people have very short term memories. Once a bull market gets some legs in it, the quest to get “the most money as quickly as possible” causes prices to get bid up. Human nature kicks in and dollar signs start appearing in people’s eyes. New methodologies are touted and fundamental principles are left in the rear view mirror. “Today is always the dawning of a new age. Things are different than they were yesterday. The world is changing and we must adapt.” Yes, all very true statements but the new and “fool-proof” methods and strategies and overleveraging and excess risk-taking only work when the economic environmental conditions allow them to work. Using the latest “fool-proof” investment strategy is like running around a thunderstorm with a lightning rod in your hand: if you’re unharmed after a while then it might seem like you’ve developed a method to avoid getting struck by lightning – but sooner or later you will get hit. And yet value investors are for the most part immune to the thunder and lightning. This isn’t at all to say that value investors never lose money, go bust, or suffer during recessions. However, by sticking to fundamentals and avoiding excessive risk-taking (i.e. dumb decisions), the collective value investor class seems to have much fewer examples of the spectacular crash-and-burn cases that often are found with investors’ who employ different strategies. As a result, value investors have historically outperformed other types of investors over the long term. And there is plenty of empirical evidence to back this up. Check this and this and this and this out. In fact, since 1926 value stocks have outperformed growth stocks by an average of four percentage points annually, according to the authoritative index compiled by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College. So, the value investing philosophy has endured for over 80 years and is the most consistently successful strategy that can be applied. And while hot stocks, over-leveraged portfolios, and the newest complicated financial strategies will come and go, making many wishful investors rich very quick and poor even quicker, value investing will quietly continue to help its adherents fatten their wallets. It will always endure and will always remain classically in fashion. In other words, value investing is vintage. Which explains half of this website’s name. As for the value part? The intention of this site is to explain, discuss, ask, learn, teach, and debate those topics and questions that I’ve always been most interested in, and hopefully that you’re most curious about, too. This includes: What is value investing? Value investing strategies Stock picks Company reviews Basic financial concepts Investor profiles Investment ideas Current events Economics Behavioral finance And, ultimately, ways to become a better investor I want to note the importance of the way I use value here. It’s not the simplistic definition of “low P/E” stocks that some financial services lazily use to classify investors, which the word “value” has recently morphed into meaning. To me, value investing equates to the term “Intelligent Investing,” as described by Ben Graham. Intelligent investing involves analyzing a company’s fundamentals and can be characterized by an intense focus on a stock’s price, it’s intrinsic value, and the very important ratio between the two. This is value investing as the term was originally meant to be used decades ago, and is the only way it should be used today. So without much further ado, it’s my very good honor to meet you and you may call me…