Investors are routinely warned about allowing their emotions to influence their decisions. However, they are not often cautioned that their preconceptions and biases may color their financial choices.
In a battle between the facts & biases, our biases may win, especially when we don’t realize we have them. If we acknowledge this tendency, we may be able to avoid making unexamined choices when it comes to personal finance. It may actually "pay" to recognize blind spots and biases with investing.
Here are some common examples of bias creeping into our financial lives.
Letting emotions run the show.
How many investment decisions do we make that have a predictable outcome? Hardly any. If we make an investment, and the outcome is good, me might think we made a smart decision. If the outcome is not what we wanted, we might think an outside factor negatively influenced the outcome. We tend to give ourselves credit for the good outcomes. It is all too easy to prize the gain from a decision over the wisdom of the decision, which might lead us to believe the best outcomes were the result of the best decisions. This isn’t necessarily true.
Put some distance between your impulse to make a change and the action to make the change. This could give you a chance to get some perspective on the emotions that affect your investment decisions.
Valuing facts we "know" & "see" more than "abstract" facts.
Information that seems abstract may seem less valid or valuable than information related to personal experience. This is true when we consider different types of investments, the state of the markets, and the economy's health. Take some time to understand new information being presented.
Valuing the latest information most.
The latest news is often more valuable than old news in the investment world. But when the latest news is consistently good (or consistently bad), it’s easy to forget the lessons from previous market experience. If we are not careful, our minds may subconsciously dismiss the eventual emergence of the next market cycle.
The more experienced we are at investing, the more confidence we have about our investment choices. When the market is going up, and a clear majority of our investment choices work out well, this reinforces our confidence, sometimes to a point where we may start to feel we can do little wrong, thanks to the state of the market, our investing acumen, or both. This can be dangerous.
The herd mentality.
You know how this goes: if everyone is doing something, they must be doing it for sound and logical reasons. Thinking there must be sound and logical reasons is often the first mistake. The herd mentality leads some investors to buy high (and sell low). It can also promote panic selling. The advent of social media hasn't helped with this idea. Above all, it encourages market timing, and when investors try to time the market, it can influence their overall performance.
Sometimes, asking ourselves what our certainty is based on, reflecting on ourselves and understanding our biases can be helpful and informative.
Examining our preconceptions may help us as we invest.
1. Investopedia.com, 2022; 2. Investopedia.com, 2021; 3. WebMD.com, 2022
Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this content, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for you or your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Searcy Financial Services, Inc.
The content of this letter does not constitute a tax or legal opinion. Always consult with a competent professional service provider for advice on tax or legal matters specific to your situation. To the extent that a reader has any questions regarding the applicability of any specific issue discussed in this content, he/she is encouraged to consult with the professional advisor of his/her choosing.
Published for the blog on June 28, 2022 by Searcy Financial Services, your Overland Park, Kansas Fee-Only Financial Planner and Investment Manager.