Behavioral Finance and Your Portfolio

6Belief Perseverance Bias #4: Representativeness Bias

Fit no stereotypes. Don't chase the latest management fads. The situation dictates which approach best accomplishes the team's mission.

—Colin Powell

Bias Description

Bias Name: Representativeness

Bias Type: Cognitive

Subtype: Belief perseverance

General Description

In order to derive meaning from life experiences, people have developed an innate propensity for classifying objects and thoughts. When they confront a new phenomenon that is inconsistent with any of their preconstructed classifications, they subject it to those classifications anyway, relying on a rough best-fit approximation to determine which category should house and, thereafter, form the basis for their understanding of the new element. This perceptual framework provides an expedient tool for processing new information by simultaneously incorporating insights gained from (usually) relevant/analogous past experiences. It endows people with a quick response reflex that helps them to survive. Sometimes, however, new stimuli resemble—are representative of—familiar elements that have already been classified. In reality, these are drastically different analogues. In such an instance, the classification reflex leads to deception, producing an incorrect understanding of the new element that often persists and biases all our future interactions with that element.

Similarly, people tend to perceive probabilities and odds that resonate with their own preexisting ...