Observing Investor Biases

Observing Investor Biases

They call it Behavioral Finance.  I call it common sense led astray by experience or lack thereof.  

 Over the years of providing independent investment advice and in a prior life being a provider/persuader pushing financial products and money management services, I became a student of the way investors typically act and why.  Firms I’ve worked for provided intense training to take advantage of known reactions to various marketing ploys. National associations and consultants to insurance agents and financial advisors provide even more intensive training to achieve sales and therefore money compensation.

 How can the average investor educate themselves to ward off the calls to action by firms or individuals taking advantage of understanding how they might react to certain strategies known to produce sales of financial products and or services?  I learned to take advantage of biases that are found in the study of behavioral finance as a seller by appealing to the greed or fear emotions.  I also learned to take advantage of several biases that investors can exhibit that can make the sale easier.

 Here are my three favorite biases that you need to know so you can be aware of their effect on your actions:

 Herd Mentality: Gold immediately comes to mind. Several years ago, now, gold took off and everyone I was meeting with had a question about this precious metal and whether it belonged in their portfolio as a security or even a hard asset hidden in a garage safe.  Gold had made a huge run up and the media were focused on it. So were our client’s neighbors and colleagues. Everyone was buying or had bought and was making lots of money.  At least on paper.  Don’t follow the herd. It’s probably too late.

 Recency Bias: International stocks have finally taken off in the last year. That means they’ll be a good bet in the future.  It’s their decade to replace the S&P 500.  I see people loading up on this index or sector believing what is happening today will continue happening.  It was painful in 2000-2002 as the dot com bubble burst, followed by 9/11 and the stocks market was down every month for months.  Lots of people thought it was going to be a complete meltdown. Just another example of being in the here and now and thinking it will continue.

 Confirmation Bias: People tend to read and are drawn to information that supports their beliefs. It’s happens when it comes to TV news and in financial decisions like reading reports and participating in conversations about that new car company that’s all electric and all exciting. After making the investment they continue to search for supporting information.  I remember in marketing class years ago that Cadillac advertising was to convince owners that had made the right purchase decision rather than compel readers to go out and buy a Cadillac.

 There are dozens more biases being recognized, labeled and studied in the area of behavioral finance.  Some authors you might want to look up include Mier Statman, Jason Zweig and Dan Ariely.  You can find a whole list of behavioral finance authors on Google.  My personal favorite is Your Money and Your Brain by Jason Zweig.

 Just take some time to remind yourself someone or some companies may be using your biases to their own advantage. Buyer beware.

Jim Ludwick
jim@adviceonly.net

Jim Ludwick is the founder of MainStreet Financial Planning. His varied education and life experiences have enabled him to apply his knowledge and experience into useful solutions for personal financial problems. His writing and broadcasting activities allow him to help many more than just individual clients. He loves a microphone.

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