Overcoming Behavioral Biases in Search of Financial Security
As human beings, we’re hard-wired to go with our gut, take action and sometimes overlook important details. It’s not always our fault; it is simply part of human nature. We call these tendencies behavioral biases, and they affect everything we do, including how we make decisions about money.
These behavioral biases do not discriminate between genders. In fact, both women and men are susceptible to these tendencies, which may be surprising given research shows that women are typically better-behaved investors than men¹. However, in the interests of our long-term financial security, it helps to be conscious of how these inherent biases may impact our financial decision making.
Together, we can overcome these biases to ensure we stay on the path to reach our financial goals. Doing so starts with recognition. Here are the top four behavioral biases we see when interacting with clients and how to overcome them:
Overconfidence bias can originate in the form of advice from a trusted individual or a glowing media report that tells you a certain stock is a guaranteed to appreciate. It is sometimes our own research that fuels overconfidence. However, if the markets have taught us anything, it is that no investment is a “sure thing,” no matter how appealing it may look. Keeping a level head and getting a second opinion is key to overcoming this bias.
- Aversion to cutting your losses
Moving on from a failing investment can be extremely hard to do, especially when we truly believed it would succeed. Many investors fall into a trap of thinking an investment will turnaround, simply because it has in the past, as opposed to assessing its fundamentals. Sometimes it is important to cut your losses and move on. Setting stop loss orders or thresholds to trigger a reassessment or conversation are key to avoid holding onto a spiraling investment for too long.
- Trend chasing
When the media latches onto a new investment trend and reports on the millions of dollars individuals are making, the temptation to jump on board can be overwhelming. By the time most of us hear about these fads, it is usually too late to invest at an attractive price. Also, these trends are almost always short-lived and rarely fit into an individual’s strategic long-term financial plan. Before pulling the trigger on a hot new stock, investors must always first consider their own specific financial goals, review the underlying fundamentals, and then decide whether or not some extra short-term cash is worth the risk.
- Familiarity bias
Human beings instinctively trust what they know, even when it comes to investing. Just because a tactic worked in the past does not mean it will work in the future. History doesn’t always repeat itself, especially when it comes to the markets. When searching for a new investment, it can be tempting to select a strategy that has worked for us in the past. However, it is almost always better to instead select investments based on their fit within our financial plans.
While sometimes hidden, these biases are within us all and can present themselves at the worst of times. The importance of a third-party perspective when making these decisions cannot be understated. This is why checking with your investment advisor is paramount to reaching your financial goals.