I recently met my friend Mike, a pilot and former lacrosse teammate that I hadn’t seen in years.
After talking about his family and friends, he reminded me that our last conversation had led him to ask where to invest, to which I asked him “What’s your biggest financial fear?” “
I had explained to him that in order to alleviate his major concerns – which at the time involved a potential dismissal but also simply losing or mismanaging his money – he had to understand the various risks and assume them all. (This conversation resulted in a column, which you can read here: https://www.marketwatch.com/story/whats-your-greatest-financial-fear-2014-06-13)
Mike said he did as I suggested and built a diverse portfolio, but his concerns changed. Within a few years of retirement, he loses sleep because of longevity risk – the potential to outlive his money – and return streak risk, the possibility of the market collapsing when it sells. retirement, which can hurt their financial plans. for all the life.
He reassesses his portfolio, assesses opportunities and decides what to do next like he’s a boss, not like a guy who asked friends – unreliable sources of knowledge and expertise – what to do.
During our conversation, I saw the following trends or biases, the same kinds of things that I constantly see and hear from investors. Identify them within yourself and you can stop the resulting behaviors before you adjust – and make mistakes – in today’s confusing markets.
Availability bias: It’s about the information used to inform decisions and what happens when the investor sees those details presented over and over again.
In Mike’s case, this applies to cryptocurrency, which attracts him because he has only read heroic stories of profit and big, easy wins from supporters. In fact, Mike’s adult son has reported successfully trading Bitcoin.
Now Mike wants to add it to his wallet because he thinks there is easy money to be made which is not the right reason to buy. He needs to look at the downside risks and the arguments against crypto so that he understands well enough to invest consistently and confidently.
Confirmation bias: An extension of availability bias involves only believing things that confirm your own thinking.
It’s the index investor with complete disregard for active management, never seeing if a different style could have a stabilizing role in a portfolio, or the growth investor who ridicules value investors for their recent struggles. decade and more.
“We maximize our confirmation bias based on the channels we watch on TV or the social media we interact with; we put ourselves in our own echo chambers, ”says Michael Falk of Focus Consulting Group. “Get out of the echo chamber.”
Loss aversion: No one likes to lose money, but most people care much more about standing out than making a profit.
In Mike’s case, his concern about return streak risk is based on the fear that real market problems cannot be pushed back forever. But he can avoid these problems by keeping some of the money on the sidelines.
The problem is, keeping that oversized cash reserve reduced the overall returns of Mike’s portfolio.
Mike justifies his decision by saying that he plans to invest the oversized cash reserve when the time is better, when he feels a crash is less imminent. The problem is, he’s parked the money since before the pandemic 2020 bear market and missed all of the rebound and recovery.
Effect of disposition: Extension of loss aversion, this is where investors hesitate to sell assets that have lost value, preferring to wait for the return to equilibrium.
“Sometimes you just can’t give up the stock picks you’ve made,” says Sneha Jose, director of behavioral finance at Stifel. “It’s so hard for you to give up and you hesitate to sell those assets that have lost value, which can lead to bad decisions over time. “
These decisions overturn the typical investment principle, with investors holding back their losers while reaping the benefits of their winners.
Breakeven was not the investor’s goal when investing, nor should it be later. If the best thing to do is sell a loser – potentially reaping tax benefits from the loss – and reinvest in something that can work better, this should happen.
Anchor bias: Anchoring occurs when investors get stuck on what they see and learn first when making a decision; it often combines with loss aversion to form a multi-faceted problem.
Mike has looked at some investments he has held for years – including mediocre mutual funds – but he still holds the hopes he had when he first invested in them, even if time suggests that he should take a close look at them for what has changed and if they are still good selections now.
Recency bias: The opposite of pegging – but behavior that can show up next to it in a wallet – recency bias is where “What have you been doing for me lately?” becomes more of a strategy than a question.
By nature, people remember recent events better; moreover, they expect these things to happen again. At a time when most experts believe the next few years of the market will not be as successful as the recent past, people who expect the market to continue to thrive after the pandemic lows of March 2020 are heading towards the disappointment.
Excessive confidence: Investors tend to believe in their own abilities as investors even though they are not experts and do not have an accurate measure of their past success.
Mike, like many investors, has been doing well since the depths of the pandemic and has seen his portfolio grow more than he could imagine during his investment life.
That doesn’t make him a good investor. Don’t confuse a bull market with sparkle.