In this reading we learn about the behavioral biases that can cause individuals to make financial decisions that deviate from what the Rational Economic Man (REM) would do. These biases can be either cognitive or emotional.

Cognitive biases, alternatively known as faulty cognitive reasoning, describe erroneous ways of thinking, reasoning, and interpreting information.

An emotional bias is a distortion of cognition and decision-making that results from emotional factors. Emotional biases are more challenging to correct than cognitive errors since they are based on impulses or intuition rather than conscious judgments.

Cognitive errors can be "moderated" - typically through education. By contrast, it may only be possible for an advisor to "adapt" to a client's emotional biases, which are less easily "corrected".

In the context of portfolio management, recognizing behavioral biases can allow an adviser to develop a deeper understanding of his clients. It may be necessary to deviate from the mean variance optimal portfolio in order to accommodate a client's behavioral biases.