Know Your Biases, Stay Objective and Long-Term
Behavioral finance is one of the most underrated and important factors that drive investor returns in the long-term.
It is a study of the psychological factors that influence investors decisions on how they interpret and act on information.
As a result, it is a burgeoning field of study in finance.
These mental shortcuts are used often when we are making complex decisions. They can bias our judgements and these
beliefs can lead to poor decision making.
(1) Anchoring Bias:
Valuing an initial piece of information too much in making investment decisions. For example, looking at an
Investment in terms of historical cost. No stock, bond, or FX position has a memory. All that matters is the
risk/reward from today going forward. Investment portfolios are littered with historical positions held because it needs
to get to “historical cost”, when the positon should have been exited long ago and reinvested in a better opportunity.
(2) Loss Aversion:
It is a bias involving avoiding losses over achieving gains. For example, studies show a 20% loss is taken worse than a 20% gain.
Often a common mistake is loss aversion means taking too little risk instead of taking enough risk to reach long-term investment goals including retirement needs, and philanthropy.
If you have a longer-term horizon low risk investments like cash erode in value vs. inflation and also controlling emotion is important.
This will be important in the current environment where investors may go overweight cash but never get properly reinvested till
global markets are much higher in price. Avoid overreacting during periods of uncertainty.
(3) Herd Behaviour Bias:
This is when investors follow other investors rather than making their own decisions. People feel more confident if they
are doing the same as other investors. Also, this manifested recently in FOMO, or fear of missing out in popular but loss making companies.
Take a step back and understand why you own an investment on its own merits and it is better to be right alone then wrong in a group.
(4) Overconfidence Bias:
This is overestimating your own investment abilities and lead to poor or rash decisions. It could involve selling our buying a large position
In your portfolio based on limited information or emotion. Furthermore, trying to time the market and thinking you can both sell and buyback into
markets when there is less volatility. Historically, investors are far lower than index returns over time due to trying to time the market by up to 50%.
Time in the market much more important than market timing.
While the first half of the year has been challenging for bonds and equities, this represents an excellent time to re-examine your asset allocation. Make sure your allocations are
in-line with your long-term return and asset allocation goals. No return without taking adequate calculated risk. Restructure, rebalance, and stick with your long-term plan.
If you are allocated correctly, do not make large changes in falling markets and try to time the market as well.