5 Behavioural Biases that lead to Financial Planning & Investing Mistakes
2022 = turbulent markets.
Clearly significant declines year to date.
Firstly, in the equity market, secondly in the bond market.
Over the past number of years, we’ve become accustomed to markets with little volatility.
Such little volatility that it’s easy to forget what volatility feels like.
Consequently, when markets draw down, panic can ensue.
When investing, it’s important to remain focused.
Focus on your own long-term goals.
Nevertheless, easier said than done.
Investing is an emotive act.
Fact, we get emotional when it comes to our own money.
Consequently, when markets draw down, our emotions can take over.
Here we highlight five behavioural biases that can cloud our judgement.
And consequently, lead to investment mistakes.
Behavioural Biases: #1 Overconfidence
Most people tend to overestimate their skills.
To see one’s self better than they are.
Particularly when it comes to managing their own finances.
When investing this can lead people to overestimate their understanding of markets.
As a result, this can then end up in a futile attempt to time the market.
Overconfidence can lead investors to believe they can make two calls correctly.
When to get in.
Along with when to get out.
Buy low, sell high.
May work once, maybe twice, but it’s not a long-term repeatable strategy.
Behavioural Biases: #2 Regret
An investor has decisions to make.
Sometimes they get put on the long finger,
Because of the fear that the decision made will be incorrect.
Thus leading to feelings of regret.
Hence it’s called regret bias or aversion.
We see this regularly.
For example, when someone is considering investing.
But they’re not sure because they do not want to invest in case the market goes down just after.
Then they don’t invest and 5 years later the market is up.
As a result, they regret not investing, instead thinking ‘what if?’.
The best time to invest is when you have the assets to invest.
And you have a well thought out investment plan.
Behavioural Biases: #3 Following the herd
Very common.
This happens when investors follow others.
Following others instead of making their own rational decisions.
Unquestionable, following the herd makes people feel safer.
However, it’s not necessarily, and most often isn’t, the best thing to do when investing.
For instance, in day to day practice.
We have clients and prospects say something like:
‘But Joe down the pub says this is what to do’ or
‘Tom on the golf course says this is a great way to invest’.
Really?
Step back, take a moment and think what’s best for you.
Not what is best for Joe or Tom.
Joe, Tom and yourself are three completely different people with three different situations.
Remember that time high %’s of the population were buying bank shares or Eircom shares?
Behavioural Biases: #4 Loss Aversion
This is where one would prefer to avoid loss than obtain an equivalent gain.
Simply put, it’s better not to lose €20 than it is to find €20.
As a result, this can influence people to avoid risk.
Leading to a couple of outcomes:
- Investors invest in an overly conservative portfolio or
- Even worse, don’t invest at all
This can also push individuals to sell in a market downturn.
Simply to avoid further losses.
Consequently, they miss out on gains when markets rebound.
Compounding their misery.
Loss aversion is why many individuals refuse to deal with inflation.
Instead of generating long term gain, they prefer consistent real loss by leaving money in the bank and letting inflation reduce it.
As well as that, loss aversion is a major reason why so many investors underperform.
It leads to irrational decisions.
Behavioural Biases: #5 Recency
Ever invest in a good time and think the green on the board will just keep continuing?
Inevitably, red will appear at some point.
Markets will draw down.
Recency bias is the tendency to put too much emphasis on recent events.
Events that are freshest in the memory.
And it’s really hard to avoid!
Recency bias can then lead an investor to think the green numbers will continue forever.
Alternatively, recency bias can lead investors to think a market downturn, red numbers, will last forever.
As a result, they make short term irrational decisions based on recent events.
Decisions that deviate from their original plans.
Keep a cool head and stay focused.
Summary
In conclusion, 5 behavioural biases that can affect your financial wellbeing.
Undoubtedly, biases can affect your judgement when it comes to making financial decisions.
When it comes to making financial decisions, it’s important not to let emotion cloud your judgement.
Do you see a bit of yourself in any of these biases?
The best way to avoid them is to have a plan and stick to it.
How We Help
We can create that plan with you.
Both financial and investment plans.
Not only that we will help you stick to them.
Provide objective and sensible views.
When it comes to our investment process we like to educate clients.
Help them understand how markets work and get them to take a broader view.
We also tell them what to expect, the expectation that at some point during an investment, markets will draw down.
It’s the nature of markets, expect it, but ride it out and be rewarded.
Furthermore, we help clients to curb their impulse to make decisions based on recent events.
And tune out the media’s thirst for the bad news.
Get in touch
Email us at info@fortitudefp.ie or request a callback.
Alternatively, you can get us on 086 0080 756 or access our diary here and book a call at your convenience.
Why not visit our insights.
A multitude of information on various financial subjects covering all aspects of saving, investing, financial planning, protection and pension advice.
Our blog posts are intended for information purposes only and should not be interpreted as financial advice.
You should always engage the services of a fully qualified financial planner before entering any financial contract.
To discuss engaging the services of Fortitude Financial Planning please email us at info@fortitudefp.ie.
Fortitude Financial Planning Ltd will not be held responsible for any actions taken as a result of reading these blog posts.
Production