Can We Overcome Bias in Investment Decisions?

investment-bias-full

22 Nov Can We Overcome Bias in Investment Decisions?

Investment planning is both an art and a science. While we have decades of factual research and real time data to draw on, judgement and human behaviour are equally as important.

But even the most experienced investor may hold certain beliefs or biases, which can impact on their behaviour and damage long-term investment performance.

The following is a brief explanation of the biases that typically affect investment decisions:

Overconfidence Bias

The belief that an investor can beat the market by virtue of their own judgement. While this has been debunked in countless studies1, many investors overestimate their own skills, and underestimate the role of luck and the wider market.

Confirmation Bias

The inclination to focus on data which supports a conclusion already made, and to ignore or rationalise data which does not. Investors may have a tip or a hunch, and rather than starting from a neutral position, they unintentionally seek out information to support it. This can result in flawed decisions.

Loss Aversion

Placing a higher emphasis on potential losses than potential gains. This can lead to investment decisions that are based on fear rather than reason.

Endowment Effect

Investors tend to place a higher value on assets they already own. They may avoid selling the asset when the data indicates that they should, or they may not give proper consideration to other, more suitable investments.

Familiarity Bias

Investors may also place a higher value on assets they are more familiar with, regardless of what the data says. Many portfolios are heavily weighted towards UK equities, despite the data suggesting that diversification is a key factor in reducing risk and improving returns2.

 

It can be challenging for an investor to overcome these biases, particularly when they are managing their own money.
Fortunately there are ways to reduce the impact of these biases on your investment portfolio.

Having a financial plan is the first step, as this allows your investment strategy to be aligned with your life goals. Chasing returns and beating the market becomes far less important when you are clear on what you would like to achieve.

Outsourcing your investment decisions is also recommended. A professional investment manager is well aware of the potential biases and will have processes in place to deal with them. Rather than deal with money on an emotional level, they have the resources and expertise to make data-driven decisions. Diversification comes as standard.

Most importantly, stay the course. The most successful investors remain invested throughout market turbulence. While there may be some changes along the way as your circumstances evolve, creating a strategy and sticking with it is the best way to overcome biases.

Please do not hesitate to contact a member of the team if you would like to find out more.

1 https://www.investopedia.com/articles/trading/10/beat-the-market.asp
2 https://www.referenceforbusiness.com/encyclopedia/Dev-Eco/Diversification-in-Investments.html