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Overview
Situation: Nobody is immune from the adverse ramifications of investing bias.
Symptom: Left unchecked, your bias can inflict long-lasting portfolio damage.
Solution: Recognize your biased patterns and muster up willpower to change.
Summary: Stop emotional attachments and adopt rational decision making.
“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 damage, such as lower returns. The goal is to become 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.” Too many portfolios are devastated by various signs of biased investing. Resolve to unravel the consequences of biased investing to regain a portfolio with purpose.
Recognize and make adjustments to bias that is holding back your money management. 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 us become better investors.
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 grandmas and grandpas don’t have.
Change this wiring soon
I highlight a few important biases 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 particular investment strategies than we actually are. Over-confidence often leads to quick decisions that we later regret. For example, 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. Then they ignore all the other people and data that contradict existing beliefs and positions. Does it sound 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 gain, versus if you realized a loss. Regardless of whether or not the investment climate is right for you.
• Impatience bias: Have you noticed that grandmas and grandpas seldom 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 grandmas and grandpas. This is an easy one to correct.
• 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 breakeven. Investors have difficulty coming to grips that every loss starts small. Further, your 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.
• 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. Remember that winners do fall prey to making sudden u-turns, sometimes turning on a dime.
• Ultra-conservatism bias: Most investors 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 65 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 more in cash instruments becomes the new mantra. 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 deer in headlights. Such investors have difficulty coming to grips with the realization that ultra-conservative investing is far riskier than the balanced approach.
Wrapping up
These behaviours ought to be of prime interest to all investors. Take sufficient time to recognize your patterns of bias. Then muster up willpower to make lasting changes. Your goal is to regain that impartial judgment, without regrets. No could’ve, should’ve or would’ve need apply.
One 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 to their stocks. Portfolio managers become a sounding board for clients. This helps immensely in your decision making.
Ultimately, take steps to stop your biased investing moves. My coverage only scratches the bias surface. Search the topic for additional examples of bias and explanations. Note that they may have multiple names. 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.
Adrian Mastracci, Discretionary Portfolio Manager, B.E.E., MBA started in the advisory profession in 1972. He is portfolio manager with Vancouver-based Lycos Asset Management Inc
Information provided is intended for educational purposes only.
Copyright ©2021, Adrian Mastracci. All rights reserved.
