how to overcome biases
understanding prospect theory can help individuals overcome their biases and make more rational choices for example an investor who is aware of their bias towards high probability events can compensate by giving extra consideration to low probability ones it also helps to reframe possible outcomes in a way that reduces the impact of cognitive biases instead of thinking in terms of gain or loss you can instead think in terms of the value of expected outcomes without using the present as a reference point this can reduce one s loss aversion bias outcomesaccording to tversky and kahneman the certainty effect is exhibited when people prefer certain outcomes and underweigh outcomes that are only probable the certainty effect leads to individuals avoiding risk when there is a prospect of a sure gain it also contributes to individuals seeking risk when one of their options is a sure loss the isolation effect occurs when people have presented two options with the same outcome but different routes to the outcome in this case people are likely to cancel out similar information to lighten the cognitive load and their conclusions will vary depending on how the options are framed 7example of prospect theoryconsider an investor who is given two pitches for the same mutual fund the first advisor presents the fund to sam highlighting that it has an average return of 10 for the last three years meanwhile a second advisor tells the investor that the fund has had above average returns over the last decade but has been in decline for the last three years prospect theory says that although the investor has been pitched the exact same mutual fund they are likely to buy from the first advisor that is the investor is more likely to buy the fund from the advisor that expresses the fund s rate of return in terms of only gains while the second advisor presented the fund as having high returns but also losses 