Behavioral Finance • Investor Biases
Monthly AIRE Perspectives – October 2021
Dear Friends and Valued Clients,
We are pleased to let you know that our move to our new and expanded offices has been completed. Our new state-of-the-art offices are located in the heart of Beverly Hills, at 9350 Wilshire Boulevard, Suite 200, Beverly Hills, CA 90212 – just one block east of our prior location. If you are in the area, please stop by and visit!
Client Portal Update
Last month, we launched our client portal, where you will be able to view your AIRE statements, performance information, asset allocation, analytics and more. We are adding functionality to this site regularly, including the ability to view your updated financial plans, an upcoming mobile app and additional updates. If you have not yet logged in, please contact us and we will get you online within minutes. You can find our portal by going to our website at www.aireadvisors.com and clicking on the link on the upper right for “Client Portal.”
Behavioral Finance and Investor Biases
As many of you know, we believe that investing based on client goals and a thoughtful plan, rather on predictions, is key to long-term success. Part of the many reasons for this is the idea that, when investing is based upon goals, timeframe and a plan, it helps investors avoid many of the behavioral pitfalls that tend to come into play when emotions get involved, such as selling at market lows (which is when the news tends to be at its bleakest) and buying at market highs (when everything seems rosy).
Based upon intensive analysis of stock pickers and portfolio managers, the overwhelming data suggests that even the foremost “experts” in the markets cannot predict the future direction of the markets, choose asset classes based upon predictions, or pick the best stocks with any degree of consistency. Yet, when the statistics clearly show this, why do so many amateur and professional investors still insist on allowing predictions to guide their investing, rather than proper asset allocation? We regularly study the field of Behavioral Finance and would like to share with you some typical investor biases, in an effort to help avoid some of these mistakes in the future. While there are about 25 various biases that are regularly taught in Behavioral Finance courses, we thought we would share 7 of the most prevalent ones with you.
Self-Attribution Bias – investors may overestimate their skills at investment selection, and tend to remember, focus on, and attribute to themselves any successes, while assigning the blame for failures to others or to bad luck. Investors can, after a period of successful investing, believe that their success is due to their acumen as investors rather than due to factors out of their control. Leads to taking too much risk.
Confirmation Bias – Refers to a type of selective perception that emphasizes ideas that confirm our beliefs, while devaluing whatever contradicts our beliefs. Confirmation bias can cause investors to seek out only information that confirms their beliefs and an investment that they have made and to not seek out information that may contradict their beliefs.
Illusion of Control Bias – The tendency of human beings to believe they can control or at least influence outcomes, when, in fact, they cannot. Observe in Las Vegas, where casinos play host to many forms of this psychological fallacy. People shake the dice more or harder in craps when they are shooting for an important number or high number. Examples in investing: (1) People who trade more or do online trades themselves believe they can control the outcome of the stock or investment (2) Illusion of control can lead investors to hold higher concentrations positions because they feel they have fate over those companies. (3) People who are successful in their profession feel they can control or be successful in picking stocks.
Hindsight Bias – “I knew it all along!” Once an event happens people tend to believe that they perceive the event to be predictable. It is the tendency of people, with the benefit of hindsight following an event, to falsely believe that they predicted the outcome of that event in the beginning. It affects future forecasting. They assume that the outcome they ultimately observe is, in fact, the only outcome that was ever possible. Thus they underestimate the uncertainty preceding the event in question and underrate the outcome that could have materialized but did not.
Recency Bias – Is a cognitive predisposition that causes people to more prominently recall and emphasize recent events and observations than those that occurred in the near or distant past. Investors look at recent information and a small sample size to determine that the market will continue based on recent data. “It’s different this time.” Can cause investors to ignore proper asset allocation.
Overconfidence Bias – Can be summarized as unwarranted faith in one’s intuitive reasoning, judgments, and cognitive abilities. Overestimate ability to evaluate a company as a potential investment. Ignore negative info that might indicate a warning. Trade excessively as they believe they have special knowledge. Underestimate downside risks. Hold undiversified portfolios and take more risk without even knowing.
Cognitive Dissonance Bias – When newly acquired information conflicts with preexisting understandings, people often experience mental discomfort. For example, a consumer might purchase a certain brand of mobile phone, initially believing that it is the best mobile phone available. However, when a new cognition that favors a substitute mobile phone is introduced, representing an imbalance, cognitive dissonance occurs in an attempt to relieve the discomfort that comes with the notion that perhaps the buyer did not purchase the right mobile phone. People will go to great lengths to convince themselves that the mobile phone they actually bought is better than the one they just learned about, to avoid mental discomfort associated with the initial purchase.
It is worthwhile to study these biases, as many of them tend to appear in everyday life, outside of investing. To this end, we want to share a recent article from The Atlantic: The Role of Cognitive Dissonance in the Pandemic. Please note that this is not at all meant to be political, but merely a good explanation and some examples of cognitive dissonance bias, which is a bias that tends to affect virtually all of us in one way or other. Being aware of these biases helps us to at least control them to some degree, whether in investing or in life. We hope you will find the piece to be helpful.
AIRE Advisors Welcomes Kristina Downing!
AIRE Advisors is pleased to welcome Kristina Downing to our team in the role of Senior Vice President - Wealth Advisor!
Kristina began her career in the financial services industry in 2005 as a Registered Client Associate at UBS Financial Services, Inc. She continually advanced in her career, first at JP Morgan, then at Merrill Lynch from 2016 to 2021, where she played a key role at a top-producing team in the Manhattan Beach office.
With extensive experience in lending, Kristina led the group’s lending initiatives, including residential home financing, home equity lines and lines of credit. She also has experience working with corporate executives, executing stock options and restricted sales for the group.
Kristina stays active by taking part in a regular spin class and is an avid runner, having completed the Denver Marathon in 2010. Kristina earned her B.S. degree in Business Administration from the University of Colorado at Boulder with an emphasis in Finance. She is an involved member in the Los Angeles community and volunteers at the Downtown Women’s Shelter.
Once again, we would like to thank you for your trust and loyalty, and look forward to speaking with you in the upcoming month.
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