How Meditators Can Overcome Behavioral Finance Biases

While behavioral finance identifies and describes cognitive errors, it provides few remedies. In fact, when Daniel Kahneman was asked what could be done to overcome behavioral biases, he told delegates at CFA Institute’s 2012 Annual Conference: “Very little; I have 40 years of experience with this, and I still commit these errors. Knowing the errors is not the recipe to avoiding them.”

The major behavioral biases stem from a lack of conscious awareness of how our minds function. The good news is that attaining consciousness is a hallmark of a meditation practice. Moreover, a recent INSEAD/Wharton research paper demonstrated that a mindfulness practice is a successful antidote to “sunk cost” bias.

Here is a guide to behavioral finance’s major biases and how meditation may help to overcome them.

Loss Aversion Bias

Loss aversion bias says that we feel pain more acutely than we do pleasure. This is another way of saying that for most people, their usual default awareness, or their normal conscious context, is to try and avoid personal harm or loss. Layer on top of this predisposition finance’s many sources of anxiety — volatile securities markets, leverage, fiscal gridlock, fiduciary duty, et al. — and you have a recipe for your brain’s instinctual center, the amygdala, to be in full-alert mode.

Fortunately dozens of studies prove that meditation lowers stress and meditation increases awareness. So instead of falling prey to loss aversion, meditating investors can take advantage of high-stress periods by calmly buying when everyone else is selling.

Representativeness Bias

Representativeness bias is essentially assessing new situations based on stereotypes. So when we hear a pitch at a sell-side event for a waste company, we tend to ignore the specific details and instead relate the presentation to our previous experience with garbage businesses. So representativeness bias is simply an example of the unconscious use of a general mental model when, in fact, actual specific data exists about the unique company.

For most of us, just before our mental model kicks in, there is a check-in with our memory: “what story do I know that is similar to this one?” Then there is a moment of cognition or connection to our memory. Meditators can tune into and become aware of the feeling of cognition. Then, when evaluating a new company, rather than fall prey to representativeness bias, meditators can interrupt the activation of the mental model when they feel it being activated: “Waste Connections really is different from Waste Management.”

Anchoring Bias

Anchoring bias means that we tend to use information familiar to us to evaluate a situation that is largely unknown to us. So if we are asked to estimate the cell phone market share of Google’s Droid, we take our knowledge of Samsung’s market share as the basis for estimating Droid’s share.

Avoiding this bias requires that we recognize when a problem in front of us actually has a factual answer. While meditating, we pay attention to what it feels like when we are ignorant of something. Then when confronted with a situation like the Droid example above, we are cognizant of the moment between feeling ignorant and the moment that our model based on anchoring bias is launched. Ignorance always has a ready-made solution: get the facts!

Confirmation Bias

Confirmation bias is focusing on information that affirms our preferred point of view. Put another way, this is the inability to separate our preferences and prejudices from reality.  More germane to the investment problem, we may think that easy monetary policy leads to inflation and therefore overemphasize evidence of inflation in consumer price index data.

Meditation emphasizes unbiased states of awareness to help identify prejudices and preferences well before they are called upon to make judgments. Using meditation to take a mental inventory of these biases allows them to be more easily recognized before we jump to unfounded conclusions. Is it really the case that too much monetary policy unequivocally leads to inflation? Even if there is 100% certainty about past facts, could it be that the present situation is significantly different for some reason? It may be that you engage in meditation and discover that while you may have a tight money supply bias, your conclusions were entirely justified.

Mental Accounting Bias

If we compartmentalize money into different categories and apply different decision rules to these categories, we are engaging in mental accounting. For instance, we do not sell a corporate bond out of a portfolio because it is part of the diversified bond fund’s “long-term capital.” Instead we sell a better-performing bond out of the “short-term capital” portion of the portfolio, thus hurting returns.

Essentially this kind of behavioral bias is the inability to break context or consider multiple contexts before making a decision. Again, meditation emphasizes non-attached, present-moment states of consciousness. As meditators progress they can hear themselves and avoid needlessly narrowing their contexts of understanding while maintaining a more holistic worldview.

Overconfidence Bias

If an analyst feels unstoppable because his picks are up 500 basis points above the benchmark this year, he is overconfident. In turn, this may lead to outsized risks being taken. Meditation’s non-judgmental self-awareness allows investment pros to look at their behavior with new eyes: “Hey, my confidence needs to be held in check. What led me to this success in the first place was thorough due diligence. But I won’t beat myself up; we all feel ‘high’ from our success sometimes.”

In conclusion, a skillful meditation practice allows investors to choose their contexts, mental models, and actions with greater awareness and non-judgment. Each of these abilities provides tools for overcoming the biases identified by behavioral finance. In fact, meditation has been helping people think more clearly and with greater awareness for 75-times longer than the 40-year history of behavioral finance.