Mental Accounting Bias, Loss Aversion Bias and heuristics

1 . Mental Accounting bias ignores correlation. I am just wondering does any other bias ignore the correlation as well?

  1. One of the consequences of loss aversion bias (disposition effect) is hold on to losers too long but may sell winders too quickly. Just forgot the reason. Why is that? If they feel more pain from a loss, wouldn’t they want to sell the losses to avoid the pain?

  2. For the heuristics , I found three concepts are related to this. Do you know any other areas mentioned the heuristics? Just trying to use this to remember some concepts.

a. the editing phase under prospect theory uses heuristics to make a preliminary analysis

b. Anchoring and adjustment bias: people use psychological heuristic experience based on trial and error rules to unduly affect Probabilities.

c. Availability bias: people use a heuristic to estimate the probability of an outcome based on how easily the outcome comes to mind.

Thank you!

  1. Yup, I guess you can consider it an extension of mental accounting, but layering in Behavioral Portfolio Theory is essentially mental accounting, where the most important goal is invested very conservatively, while risky assets are allocated to more aspirational goals. This is done without regard to the correlation between layers, therefore the overall asset allocation is sub-optimal. 2. Loss aversion deals also with not wanting to accept/realize a loss. therefore by holding onto a losing position in the hope that it will recover, the investor is essentially in denial and avoiding the realization of the loss. This can also lead people to doubling down on a losing position. On the other hand if the investor has an unrealized profit, they are worried that that gain might be lost, so they rush to realize the gain to avoid the unrealized loss. Now juxtapose this with regret aversion, where investors don’t sell winners because they are worried that they will miss out on further gains. 3. Ummmm I am not sure on this one, haha.

for C, I’d say the main one tends to be representativeness. IF X THEN Y, generally without further due diligence

Thanks all for the help!

I agree that BPT, Mental Accounting and Goal Based Investing are all related to each other. Just saw another post. " goal based investing is to accommodate biases. BPT explains that there is a reason for goal based investing to exisit."

If so, availability bias and representativeness are very similar. Just reviewed a topics test question “as a result of availability bias, investors may choose an investment based on advertising rather than a thorough analysis of the options.”

Then, how do we separate these two biases? Hope we don’t have question listing both…

  1. Mental Accounting bias is the only bias that ignores correlation among various assets as people suffering from this bias do not make investment decisions in risk/return context.
  2. Loss aversion bias : the reason behind holding on to losers too long while winners too quickly is that people exhibiting such bias would accept more risk to avoid losses than to achieve gains --> recall myopic loss aversion --> exhibiting greater sensitivity to losses than to gains.


What: Using overly simple if-then or rule-of-thumb decisions instead of thorough analysis. Individuals use heuristics (experience) to classify information: “IF it looks a certain way THEN it must be in a certain category.” There are two forms representativeness bias can take: Base-rate neglect is where new info is given too much weight relative to the old information whereas sample-size neglect refers to the assumption that small samples represent the entire population

Consequences: New info is given too much weight, often using simple classifications or stereotypes rather than engaging in the mental effort of updating beliefs (e.g. buying a stock simply because it is in country X or investing with a manager based on short-term results), base decisions on small sample sizes

Mitigate: Consider actual probabilities, focus on historical returns (periodic table of investment returns)


What: Focus on info that is easy to find, or focus on easily remembered past experiences, possibly depending on heuristics or rules of thumb. Caused by:

  • Retrievability: How easily/quickly something is recalled
  • Categorization: Using familiar classifications (even if not relevant)
  • Range of Experience: Narrow experience can cause estimation bias & narrow frame of reference
  • Resonance: People evaluate situations relative to their own likes/dislikes/circumstances and use those to judge or compare

Consequences: Easily recalled & understood events perceived as being more likely. Select investments base on advertising, may lack diversification because they limit their opportunity set or over-invest in firms and industries that resonate with them. Common issue with analysts

Mitigate: Use an investment policy statement, thorough research, focus on long term results.

Thanks, s1mple! This is an area I still need to work on especially with all the mitigation methods. There some overlaps and one example could show multiple bias. So that is why if was during the exam, I am not sure If I will be brave enough to use the same reason like the one below.

On 2014 morning exam question 11 Part A.

Lam has both Availability and Representatives biases.

One of the reasons for Representativeness is exactly the same as Availability "Lam demonstrates representativeness/availability bias by investing in companies that remind him of his most successful corporate clients since “THEY KNOW WHAT WORKS”.

They also list another reason for availability “Lam gets some investment ideas from advertisements by industry trade groups and from blogs sponsored by the companies he is researching, rather than considering additional independent resources.”