Suffering from investing bias?

Tuesday, June 13, 2017|Managing Investment Risk|
  • Investing Bias

Situation

Nobody is immune from the adverse ramifications of investing bias.

Symptom

Left unchecked, bias can inflict long-lasting portfolio implications, such as lower returns.

Solution

Recognize your biased patterns and muster up willpower to change.

Summary

Investors are asked to replace emotional attachments with rational decisions.

“The art of being wise is the art of knowing what to overlook.”
— William James (1842–1910), American psychologist and philosopher

Our investment behaviours are dramatically influenced by the bias we keep. Left unchecked, bias can inflict long-lasting portfolio implications, such as lower returns. The goal is to become better aware of how bias affects the outcomes of investing behaviours. My challenge is extended to all investors.

Bias has many definitions, such as, “a preference or an inclination, especially one that inhibits impartial judgment”. We review too many portfolios devastated by various signs of biased investing. Resolve to unravel the consequences of biased investing and you will regain a portfolio with purpose.

Recognize and make adjustments to bias that is holding back your money management moves. Step out of your comfort zone and revisit your biased behaviours. All investors can resolve to make simple and sensible bias alterations. This process helps all of us become better investors.

Our investment behaviours are dramatically influenced by the bias we keep. Left unchecked, bias can inflict long-lasting portfolio implications, such as lower returns.

Nobody is immune from the adverse implications of investing bias. Researchers point out that our brains are wired with many preset investment bias, professionals included. Thankfully, the wiring is easily changed. In addition, portfolio managers devote plenty of effort in minimizing the affects of bias found in client portfolios.

Delving into a few amusing behaviours of investing is a fascinating subject. My favourite is the impatience bias that grandma and grandpa don’t have.

Change this wiring soon

I highlight 11 important bias cases for you to recognize and change:

Over-Confidence Bias
The most common investor bias by far is over-confidence. That is, believing that we are more savvy and wise about a particular investment topic than we actually are. Over-confidence often leads to quick decisions that we later regret. Such as investing too much money into one or two “surefire” stock selections.

Confirmation Bias
Investors have built-in desires to find facts, figures, data, trends, information, people and institutions that agree with their existing views. The next step is to ignore all the other people and data that contradict existing beliefs and positions. Does it sound too close to home?

Recency Bias
Your next investment decision can be unduly influenced by the outcome of your last trade. You are more receptive to investing if you just realized a capital gain, versus if you realized a capital loss. Regardless of whether or not the investment climate is right for you.

Impatience Bias
Have you noticed that grandmas and grandpas rarely get mad or annoyed for very long with their grandchildren? In contrast, the children’s moms and dads may reach the hot point with the same children much sooner. This observation also applies to their investment portfolios. Those grandmas and grandpas have more patience with portfolio outcomes, versus their sons and daughters. Consequently, the moms and dads reach more emotional resolutions and/or fewer logical decisions than grandma and grandpa.

Direction Bias
Research shows that if investors experience two consecutive up days in the markets, they assume that the third day will also be an up day and invest accordingly. Similarly, two consecutive down days produce the expectation of a third down market day. However, these are only our expectations and have nothing to do with realities of market direction.

Home Bias
Americans typically have too much of their portfolios in US stocks. Asians invest heavily in Far East companies. Europeans load up on their home country favourites. Similarly, Canadians invest too much in Canada. Home bias is a global investing conundrum sporting no favourites.

Loss-Aversion Bias
Too many investors have a flavour of loss-aversion bias, also known as denial bias. That is, the refusal to sell a losing stock until its price returns close to break even. Investors have difficulty coming to grips that every loss starts small. Further, the first loss is the best loss. Consequently, they hold on far longer than is prudent. Selling a loser is an admission of failure, which goes against our emotional tendencies. Three little words say it all, “I was wrong”.

Over-Reaction Bias
Investors often go overboard both on the upside and downside. Nobody likes to admit it, but practically everyone has jumped onto an investing bandwagon near or at the top. Similarly, many also jumped off near or at the bottom.

Familiarity Bias
Investors choose investments they recognize over those they are not as familiar with. This familiarity often results in skewed preferences for domestic investing over foreign choices, selecting known companies versus unknown ones, or investing heavily in a particular sector or industry. Familiarity bias typically shows up as reduced or insufficient portfolio diversification.

Winning Team Bias
Investors have strong desires to associate with winning teams. Tendencies to identify with top investment picks, such as owning the “top 10 mutual funds”, come to mind. Winning teams make us feel happier, more secure and comfortable. Especially, if they also provide a certain cache and bragging rights. Just remember that winners do fall prey to making quick u-turns, sometimes turning on a dime.

Ultra-Conservatism Bias
Most investors that I encounter are comfortable owning a balanced asset mix of stocks and bonds, often for the lifetimes of both spouses. However, a sense of ultra-conservative investing begins to develop for some as age 60 draws near. Extreme fears of incurring a decimated retirement nest egg drives these investors to exit stocks for the perceived safety of the sidelines. Owning far more in cash instruments than is considered prudent. They develop high aversions to growth investing even though their game plan calls for it. It’s similar to becoming frozen in time like a dear in headlights. Such investors have difficulty coming to grips with the realization that ultra-conservative investing is far riskier than the balanced plan.

Wrapping up

These behaviours ought to be of interest to all investors. Take sufficient time to recognize your patterns of bias. Then muster up the willpower to make lasting changes. You want to regain that impartial judgment, without regrets. No could’ve, should’ve or would’ve need apply.

A reason for investors to engage the services of a discretionary portfolio manager is that the years of training minimize the possibility of falling prey to the ravages of bias. It allows the managers to make better decisions, keeping in mind the investor’s best interests.

Portfolio managers know that markets are logical and rational. On the other hand, investors are driven by emotional attachments. The ability of a team of portfolio managers to become a sounding board for one another also helps immensely in decision making.

Ultimately, take steps to end your biased investing moves. My blog posting tips just scratch the bias surface. Search the topic for additional examples of bias and explanations. Your investment professionals can assist.

Any one bias is capable of causing much portfolio havoc. Accordingly, I encourage you to take up my challenge. I’m asking you to replace those well-entrenched emotional connections with logical and rational decisions. Your investing habits will improve. It’s an interesting exercise in behavioural finance, well worth your time and efforts.

About Adrian Mastracci, Discretionary Portfolio Manager, B.E.E., MBA  My expertise in the investment and financial advisory profession began in 1972. I graduated with the Bachelor of Electrical Engineering from General Motors Institute in 1971. I then attended the University of British Columbia, graduating with the MBA in 1972. I have attained the “Discretionary Portfolio Manager” professional designation. I am committed to offering clients the highest standard of personal service by providing prompt, courteous and professional attention. My advice is objective, unbiased and without conflicts of interest. I’m part of a team that delivers comprehensive services and best value in managing client wealth.

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