Here we are, poking fun at that powerful, yet delicate, and sometimes malfunctioning, piece of anatomy called the human brain.
Investor biases fall into two 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.
Why do I spend time on this topic? Because it is important for a financial advisor to recognize investor biases to be able to give the best financial advice and guidance. In reality, oftentimes this skill helps us to protect investors from themselves.
Cognitive Dissonance
This is the “it’s not really so bad” mental justification that often occurs when a favoured stock or fund drops 50% and the investor still loves it.
Defined as “a state of mental imbalance that occurs when contradictory cognitions bump into one another.” The situation becomes psychologically uncomfortable.
What happens when glaring reality meets steadfast perception?
Investors are motivated to try to reduce this “dissonance” through rationalizing it away – why it is, or is not, fine. People will go to great lengths to convince themselves that they made the right decision. (Some of this is ludicrous. I am going to write a book on that someday. It will be a black comedy.)
The Status Quo
Have you ever heard of the “paralysis of analysis”? This falls into the status quo emotional bias.
Defined as “a predisposition of people, when faced with a wide variety of choices, to choose to keep things the same.”
This is easy to fall into, because it is easy to do nothing and/or avoid taking responsibility. It drives your advisor crazy!
This bias can cause investors to hold investments which they are emotionally fond of or comfortable with for no quantifiable reason.
Unfortunately, investors end up sabotaging their own progress toward achieving their financial goals with this bias.
Want to talk through your situation? Contact our team and we’ll be happy to help.
Bruce