We were interested to receive this great article in our inboxes recently from the Business Insider summarising how cognitive bias can impede good decision making.
Many of the biases covered apply readily to the wealth destroying behaviours we look to protect our clients from when it comes to their decision making around investment and risk.
To pick out just a few from the article, anchoring is a common bias we experience as people fixate on a certain share price for their stock or a particular price for their property. They often have their own reasons which at first can be compelling but in reality the market decides the price of an investment.
Confirmation bias is another powerful factor. We often meet people in the profession (and out) who despite being as rational as they come, simply will not accept that there is no art to investing. This is despite the overwhelming evidence to the contrary. Successful investing is a science and there really is noone out there with a crystal ball or a golden ticket to consistent outperformance compared to the market.
Many investors will look to the recency of the performance of an investment, share or asset and use this information to project how the asset will perform in the future. Many readers will be familiar with the particularly British obsession with property and that ‘you can’t go wrong with bricks and mortar’. Those with short memories would do well to consider the travails of the UK property market in 2008 for a reminder that this is not an asset class without its own unique set of risks.
Many believe that investment risk is just about how the value of their portfolio fluctuates, but there is so much more to risk. Recognising our own cognitive biases is important and behavioural risk is real. In Vanguard’s November 2014* paper on quantifying the value which good advisers can bring, they found that those who adopt an investment philosophy such as ours can deliver additional value of 3% per annum of which 1.5% can be attributed to behavioural coaching.
Given the enormous impact behaviours and biases can have, we understand how important it is that we help our clients manage them. We devote considerable time to challenging, coaching and guiding our clients with respect to their financial decisions as a crucial part of our role as their Personal Finance Directors.
Do you recognise any of the biases in your own investment decision making?
If you would like to hear about how we manage risk I would be delighted to share some of our experiences, why not get in touch?
* Quantifying Vanguard Adviser’s Alpha in the UK – Peter Westaway, Ph.D., Todd Schlanger, CFA, Francis M. Kinniry Jr., CFA, Colleen M. Jaconetti, CPA, CFP, Michael A. DiJoseph, CFA – November 2014