WealthyStreet Academy
WealthyStreet Academy

What Biases Are Pulling Strings in Your Portfolio?

Olivia Stacey, CFA
Nov 24, 2020

Investment BiasesThe Holidays are approaching. That joyous time of year when you throw on the scarf Granny knitted you last year, plaster a smile on your face, and endure endless unsolicited opinions from those closest to you. Recent years have had the internet aglow with articles on how to handle political talk at the table over Thanksgiving dinner. Normally, this year wouldn’t be any different. In fact, it would probably be much worse. However, a global pandemic is keeping us from gathering with our loved ones for poultry and pie. While COVID may be keeping us from our families, it isn’t slowing political conversation and argument. Even with the election behind us, I’d wager most of us still have family and friends looking to have heated conversations.

Something's Lurking Inside Our Opinions

I have my own personal beliefs, but what’s more interesting to me is why people think the way they do and how they go about arguing their opinions. I’ve read my fair share of articles giving advice on how to handle these tiresome conversations and something that's stuck with me is the idea that many of us often fall prey to something called belief perseverance. The American Psychological Association defines belief perseverance as “the tendency to maintain a belief even after the information that originally gave rise to it has been refuted or otherwise shown to be inaccurate.” Are alarm bells going off in your head? Thought so.

Even if you’re not familiar (or can’t think of real-life examples) with belief perseverance, I bet you know of its close cousin: confirmation bias. This is the tendency to recall, interpret, favor, and even search for information that confirms or supports your personal beliefs. I bet you know a few people guilty of that one. I bet you’ve been guilty of it. I know I have.

Personal Beliefs Aren't the Only Place Biases are Hiding

The reason I find these behavioral phenomena to be interesting is because they are not unique to political opinion. In fact, they’re everywhere. Most notably for someone like me is how they show up in investing and money management. Yep, that’s right. The same biases that are at play during your 5th argument with Auntie Tina over whose immigration plan is better are affecting your financial life as well.

If you’re a regular reader of our blog here at ECM, you may have noticed we often drop hints about how emotions and regular human behavior can affect a person’s financial decisions. The emotions that cause our irrational (human) behaviors can often be attributed to a specific behavioral bias. Certain people may be more prone to certain biases and sometimes broad economic and social situations can cause biases to occur more frequently, and on a larger scale, than usual. For example, the stress associated with the recent election and the global pandemic are having detrimental effects on our psyche, causing some biases to become more prevalent in the current situation.

Some behavioral biases that may be more frequently occurring at this time (whether it be in political discussion or investment):

Action Bias- The impulse to take action, in any way, in an attempt to gain control over a situation.

Present Bias- Based on the idea that humans are time-inconsistent, this bias causes people to place greater value on a payoff today than they would on a payoff in the future, often to the detriment of our future selves.

Recency Bias- Causes an individual to favor recent events and outcomes over historic ones.

Herding Behavior- An investors’ tendency to follow what other investors are doing, rather than their own analysis.

Overconfidence Bias- Harshly put, the tendency to overestimate our own skills and abilities.

Loss Aversion- The tendency to prefer avoiding a loss to realizing an equivalent gain.

Interested in learning more? Download our free guide to understanding and overcoming internal biases in investing.

Why am I telling you this?

I cannot stress enough that we are all guilty of a multitude of these biases, it's a natural consequence of being human. As with most things, awareness is the first step toward correction. Just by recognizing that these human behaviors exist, occur naturally, and have real impact on our desired outcome, we can (hopefully) begin to realize when they’re happening to us and work to correct them.

That being said, it's very difficult to avoid human nature just by be being aware of it (or we'd all be much better off). Often times, it's beneficial to put outside systems to work to keep you from harming yourself. Placing a well-intentioned obstacle between your knee-jerk reactions and something you care about can often save you from emotion.

When it comes to your financial livelihood, working with a financial advisor puts a thoughtful and experienced individual in that place. Putting a professional between your emotions and your money is one of the smartest moves you can make. That, and choosing the chair closest to the dessert table at Thanksgiving dinner.

New call-to-action

Olivia Stacey, CFA is an Investment Advisor at Exchange Capital Managementa fee-only, fiduciary financial planning firm. She also writes with our Investment Team: The West Wing. The opinions expressed in this article are her own.