Are your Investment Decisions as Objective as you Think?

Aspen’s CEO, Andrew Spece, did a webinar recently with the Financial Planning Club on behavioural biases – a topic that the team at Aspen find deeply interesting. The patch of land that lies between psychology and finance, behavioural finance explores how humans interact with financial decisions when our minds are hard wired to process information quickly and, as a result, can behave a little oddly. 

Behavioural biases are predictable psychological tendencies that lead people to make irrational or suboptimal decisions. For investors, behavioural biases can cause them to lose money or achieve lower returns over time, encouraging reliance on emotion or mental shortcuts rather than objective analysis.   

There are many types of behavioural bias. Most common is recency bias, where you give too much weight to recent events or performance. Other manifestations of recency bias: chasing last year’s best-performer, assuming a market rally will continue indefinitely, over-reacting to short-term news or market movements or, critically, abandoning a long-term strategy on the back of a recent period of poor performance. 

Alternatively, confirmation bias may occur, defined as seeking out or favouring information that supports your existing investment views, and overlooking information that contradicts them.   

Other common biases include: 

• Loss Aversion: when you feel the pain of losses more strongly than the satisfaction of an equivalent gain, which can lead investors to avoid sensible risks. For example, an investor may hold on to a plummeting stock as they are reluctant to accept a loss, instead hoping that the price will bounce and all will be well. Equally, loss aversion is the bias behind the drive to sell during market wobbles. 

• Herding: following the actions of other investors rather than making independent investment decisions – driven by a fear of missing out or being wrong. Think copying a friend who has recently bought shares in a company promised to ‘shoot the lights out’ before assessing whether it is a suitable investment for you. FOMO is real!   

• Familiarity & Home Bias: the home birds who prefer investments, companies or markets that are familiar or close to home. The result? A possible case of insufficient diversification. 

• Anchoring Bias: making investment decisions which rely too heavily on an initial piece of information, such as a purchase price or previous value. The ‘I’ll wait until I get my money back’ conundrum.   

The role of the adviser is crucial when it comes to helping clients navigate the emotional turmoil that can sometimes come with investing. Education, careful explanation and diversification are great friends of the biased investor. Setting long term goals and allocating capital accordingly can help too, but beware, mental accounting might set in. 

Supposedly paraphrasing Mr Buffet, discipline is key!