Friday, 15 November 2013
The next cognitive illusion is known as availability bias. When confronted with a decision, humans’ thinking is influenced by what is personally relevant, salient, recent or dramatic. Put another way, humans estimate the probability of an outcome based on how easy that outcome is to imagine.
Consider the following example. In the months after the September 11 terrorist attacks, travelers made the decision that travelling to their destination by car was a far safer way than by air. In light of the very recent (at the time), salient and dramatic events of September 11, this decision seemed an obvious and wise one. The probability of danger when travelling by air seemed much greater than travelling by car… when you think about it, at that time, it was far easier to imagine something bad happening when travelling by air.
However, this was the availability heuristic at work. The truth of the matter was that firstly, air travel had never been safer than in the months following September 11, on account of the massively increased security. And secondly, on account of far more people hitting the roads come holiday time, there were inevitably many more fatal accidents. Upon examination of the statistics, it was far more dangerous to drive than to fly (US road fatalities in October-December 2001 were well above average) and yet, the availability bias humans suffer from made many feel that driving was the smarter choice… this decision-making error cost some people their lives.
We also apply this bias in the world of investing. For instance, availability bias can result in our paying more attention to stocks covered heavily by the media, while the availability of information on a stock influences our tendency to invest in a stock. The dot.com boom of 1999/2000 is a great example. The availability of information and media coverage of internet stocks was such that people were more inclined to invest in them than they would have otherwise been.
Be wary of following the latest market fad simply because of the availability of information. If you have read it in the newspaper, you may well be amongst the last in the market to know!!