INVESTOR BIASES: DEALING WITH THE HUMAN-NESS OF PRIVATE WEALTH ADVICE

As previously described in my last blog , investor biases fall into 2 categories; Cognitive Biases and Emotional Biases. Some call them “heuristics” – or simple rules of thumb, beliefs or judgement calls. But they are much more than that.  They need to be recognized by the advisor to be able to give the best financial advice and guidance.

Remember, cognitive biases are basic information processing or memory errors common to all human beings. They can often be overcome with correct information and guidance on the topic.

“Overconfidence”.  Number One on my list of Cognitive Biases.

Generally defined as:

  • “an unwarranted faith in one’s intuitive reasoning”.
  • That is people think they are smarter and have better information than they actually do.
  • They overestimate their predictive abilities and precision of the information they possess.
  • Also known as the “it’s a sure thing” syndrome.
    • This bias is evident when a client comes to us after reading a very compelling internet story and/or is referred to it by their brother-in-law – therefore they become convinced it is 100% correct and true and MUST be invested in it by end of the day.
      • Example – “$149 for RIM is just the beginning, I have been following it on BNN and my buddy works there and says…”

Next, emotional biases in clients are more difficult for the private client advisor to deal with. They stem from illogical or distorted reasoning rather than conscious effort.  They are often involuntary, related to feelings and misperceptions of reality.

“Loss Aversion” hits the top of the charts as my number one Emotional Bias.

Generally defined as:

  • People general feel a stronger impulse to avoid losses, than to make gains.
  • The possibility of a loss is twice as powerful a motivator as the ability to make a similar sized gain
  • Oddly, this bias can actually cause greater losses
    • This is evident when a client will not unload a losing security – or any investment for that fact – even if they see little chance of a turnaround.
      • Example – “ Yeah, I know RIM is down to $7.00, but no way am I selling it now, not until it breaks $300. I can’t lose that kind of money”.

 

Do you see yourself in these biases?  Hang on – there are lots more to come …

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