This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Many great stories and sagas build on the theme of an “inner battle” within the self. Great investors also experience this reality. Various “biases” try to pull them towards irrational decisions with their investments. Yet, how can you conquer the irrational assumptions, beliefs and temptations which may lead you to act contrary to your own best interests?
Below, our Padiham financial planners highlight five common “investor biases” as you navigate your investor journey. We explain how they typically emerge in an individual’s mind and offer ideas on how to address them productively.
We hope these insights are helpful to you. Please get in touch for more information or to discuss your own financial plan with us.
#1 Loss aversion
It is well-documented that humans experience a loss more acutely than a reward (by a factor of 2). This was a useful instinct when humans were a primaeval species trying to maximise survival in the wild, avoiding harmful animals and plants.
However, it is often less useful for investors. It can lead us to be overly cautious when buying an investment. Conversely, loss aversion can lead an investor to hold onto a “doomed” investment for too long. Or, it can lead another person to engage in “panic selling” the moment their asset falls slightly in price!
One of the best ways to address loss aversion is to stay focused on your long-term goals. If your aim is to generate steady overall growth over, say, 10-20 years, this provides some much-needed perspective when your portfolio fluctuates in the short term.
#2 Recency bias
Investors often place greater “weight” on recent events when considering factors for decision-making. Perhaps the Bank of England (BoE) recently changed or held interest rates, and investors quickly reacted to try to “time the market.”
However, this approach can be dangerous because it can ignore longer-term historical events and trends. Short-term market fluctuations are obsessed over, whilst the broader investment landscape is neglected.
Investors can help protect themselves against recency bias by not simply chasing after investments that have recently performed well. It helps to access information from multiple sources (not just your preferred media or social media channels), seeking diverse perspectives which challenge your assumptions.
#3 Anchoring bias
Similar to recency bias, anchoring bias happens when an investor relies too heavily on a specific piece of information (or reference point) when making decisions.
For instance, an investor may become obsessed with an arbitrary benchmark—e.g., a purchase or sticker price. Perhaps an investor holds certain shares that have fallen in price. He assumes they should return to their original purchase price without considering how the “fair value” might have declined.
In this example, the investor may hold the shares longer than necessary, incurring an opportunity cost by not selling and using the cash better elsewhere. To help guard against anchoring bias, an investor should seek multiple reference points when evaluating investments and avoid making decisions based purely on recommendations from others.
#4 Familiarity bias
This can happen when an investor builds a portfolio and favours investments, industries, or markets they are familiar with. In particular, British investors often fall prey to “home bias”—mainly investing in UK-based opportunities and neglecting those overseas.
The danger of familiarity bias is that it can undermine diversification, exposing investors to needless risks. For example, if you invest purely in your home country (because it is “what you know”), your portfolio could be disproportionately harmed if that country experiences a recession or market crash even as the rest of the world sails on.
Working with a financial adviser is one of the best ways to help you break out of your comfort zone when building a portfolio. They can help you survey a range of pre-vetted global investment opportunities and guide you through areas of your knowledge which may be lacking.
#5 Herd mentality
When the investment “crowd” appears to be flocking in one direction (e.g. towards a “hot” stock or fund), it can be very difficult for an investor to choose another direction. We tend to assume the majority must be “right”, having access to information we have missed.
Yet this is not necessarily so. Large crowds—even investors—can get things wrong. A good example is the Dot-Com Bubble of the late 1990s, when “fear of missing out” (FOMO) drove large numbers of investors to flock to internet-based stocks. When valuations reached unsustainably high levels, prices crashed, and many people lost a lot of money.
Fighting herd mentality requires having high confidence in your own investment strategy. Keeping a long-term perspective and holding to a strict set of criteria when selecting, holding and relinquishing investments will also be helpful. Finally, make sure to build a portfolio with a financial adviser which reflects your goals and attitude to risk.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you.
Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
