Avoiding Investment Biases: 4 Ways a Financial Advisor Can HelpAugust 22, 2018
One of the biggest challenges for investors is avoiding their own instinctive behavioral biases. Learn how a financial advisor can help you avoid 4 common investor biases.
Making smart decisions when it comes to money can at times be tricky. One of the biggest challenges for investors is avoiding their own instinctive behavioral biases. These biases can lead investors to make illogical or irrational decisions when it comes to investments and wealth management as a whole. If you don’t have a financial advisor to help manage your investments, you should consider it!
What exactly is a bias?
A bias is a human tendency that impacts our behavior and perspective, based on predetermined mental notions and beliefs.
What kinds of financial biases are out there?
Investors may encounter financial biases if they do not consult a financial advisor. When it comes to our wealth, sometimes we need a second opinion! Here are 4 common biases you might encounter:
- “Hot hand fallacy”- This is the flawed belief that because you had a string of success, you are more likely to have success moving forward (a common problem among gamblers). When it comes to investing, the hot hand fallacy can take hold when investors make decisions based only upon recent information (as opposed to all available data). Investors in this scenario can often be lead to believe that the current market trends are the best predictors of what will happen with their investments moving forward. In many cases, investors start to invest more money than they can actually risk.
Avoid this bias by: Focusing on the “big picture.”
Consult a financial advisor. He/she can help you focus on more complete market data and not just recent trends, as well as how that data fits into your overall financial plan.
- Hindsight bias, or the “Knew-it-all-along” bias- When you look at your past financial decisions and think, “Well, I knew that was going to happen,” you are dealing with a hindsight bias. The hindsight bias tends to give investors a false sense of security in that they overestimate the accuracy of their past predictions. Investors may select investments according to a hunch or gut reaction rather than the facts.
Avoid this bias by: Focusing on the data, not your predictions.
The future is never predictable, especially when it comes to investments. A financial advisor can help you make sound investment decisions (by analyzing your overall financial goals and how your specific investments can help you achieve them.) This avoids a hindsight bias getting in the way that could prevent you from moving forward.
- Regret aversion- This is the decision making process based on avoiding emotional pain in the event of an adverse outcome. In other words, when facing a decision, an investor may anticipate regret and incorporate this anticipation into their choice. This bias causes investors to lose out on gains because they avoid or delay making decisions (for fear of loss).
Avoid this bias by: Setting rules for yourself.
Your financial advisor is well-trained to avoid this bias- he/she can create an investment policy statement for your investments. For example, whenever an asset class deviates from the investment policy statement, your advisor will rebalance the portfolio.
- Confirmation bias- When you find more reasons to support your own belief, by consulting Google, for example, you are using confirmation bias to aid your decisions. Investors will often seek out information that supports (or confirms) their belief system, and ignore contrary information that threatens the validity of their beliefs.
Avoid this bias by: Steering away from media influence on your investment decisions. Your financial advisor is well-trained to research and evaluate investments that are best for you. Following the crowd often does more harm than good. Your financial advisor will have a good handle on what you should and shouldn’t invest in.
While it may be easier said than done, protecting your finances from your emotions is key. If you need help avoiding biases and emotional investing, a financial advisor is the way to go. They can provide objective advice for you and your financial success!
We can help you navigate your investment portfolio. Contact any member of KLR Wealth Management, LLC.