If you’re a client-facing advisor, you’re likely adept at managing the behavioural biases of your clients.
You might also consider how you handle your own biases, as certain ones exert more influence over advisors, compared to clients.
For clients, common biases include herd behaviour, status quo bias and loss aversion, says a Richardson GMP report. These involve, respectively, relying on group thinking, refraining from taking action out of fear and avoiding losses because the subsequent pain is greater than would be the pleasure from a similarly sized gain.
More evident in advisors, says the report, are confirmation bias, overconfidence and anchoring. In fact, a firm survey found that almost three-quarters of financial professionals admitted to having confirmation bias; more than half, overconfidence and anchoring.
Confirmation bias is a tendency to seek out information or viewpoints that align with your pre-existing opinions.
“We do this because it actually makes us happier reading or listening to views that reinforce ours [and] gives us greater confidence in our beliefs,” says the report.
However, the bias is a serious risk when making investment decisions.
“Focusing mainly on research or ideas that aligned with our views can lead to increased portfolio concentration, becoming so emboldened that we are right that we continue to add to a theme, industry [or] stock,” says the report. Or you might discredit contrary information and subsequently miss a market move.
An example of confirmation bias is believing in the infallibility of Amazon.
That might seem like a no-brainer, “but many thought the same of Xerox in the 1970s [and] IBM in the 1980s,” says the report.
To overcome the bias, consider why or how your perception could be wrong, suggests the firm. Doing that—as well as putting a probability on what could go wrong—will help open your mind to contrary opinions.
Overconfidence is believing your abilities are greater than they are—a common misconception for most of us. For example, when asked if they’re above average at what they do, most people respond affirmatively, notes the report.
In finance, evidence refutes the belief that skills can help you pick outperforming stocks. “The markets are a dynamic system […] influenced by the participants. Believing you can solve it is hubris,” says the report.
Further, overconfidence can lead to under-diversification, excessive trading or performance chasing.
Once again, analyzing your views and how they could be wrong helps, says the report, along with asking another professional to poke holes in your arguments.
Anchoring refers to how exposure to a number can affect your subsequent responses.
“In the investment world, anchoring is how investors can become anchored by their original purchase price or another arbitrary price level, such as a high that was previously reached,” says the report. “This is partially related to loss aversion.”
The potential result: holding on to an investment for too long while it continues to lose value.
To mitigate against anchoring, Richardson GMP suggests ignoring references to original costs. In practice that means “there is no reference to cost anywhere on our spreadsheets,” says the firm. “Position size and weight in the portfolio is much more important.”
After an investment decision is made, the cost is then considered for tax purposes, which could potentially reverse the decision, adds the firm.