Brainwashed by Behavioral Biases? New Study Includes Effective Ways to Keep Your Investing Wits
October is here again, and with it comes Halloween – a celebration with its roots in the ancient Celtic festival of Samhain, a time when the barriers between the physical and spiritual world supposedly grew thin, and people lit bonfires to ward off ghosts.
Although Halloween only lasts for one night, it may seem like it’s been playing out for nearly two years. Since early 2020, we’ve faced a global pandemic, a contentious presidential election, numerous natural disasters, and a growing sense of unease about the future. According to a recent report by Cerulli Associates, Charles Schwab Asset Management, and the Investments and Wealth Institute, these world events have contributed to a surge in behavioral biases among investors, leading to some unseasonably scary decisions.
In its third year, the so-called BeFi Barometer measures financial advisors’ observations of behavioral biases within their client base. According to the study, in 2021, observations of each bias increased at least 11 percentage points over the previous year, with an average gain of 18 percentage points across options. As in previous years, recency bias – in which an investor is easily influenced by recent news events or experiences – was the most widely observed, followed by confirmation bias – seeking information that reinforces existing perceptions – and framing, in which a person makes a decision based on the way information is presented.
The study also asked advisors which techniques they thought were most effective in helping their clients stay objective and stick to their investing strategies. The top five are:
- Taking a long-term view. Here at Savant, we take an evidence-based approach to investing, which uses historical data, research, and our firm’s knowledge of risk and return to maximize the likelihood of achieving our clients’ desired outcomes. Inherent in this approach is patience and a long-term view. A recent article by Dimensional Fund Advisors demonstrates how those who reacted emotionally to headlines during the so-called “lost decade” also experienced poor investing outcomes. As DFA points out, if an investor had hypothetically invested $10,000 in U.S. stocks in January 2000 and stayed invested, their investment would be worth approximately $38,400 at the end of last year.
- Integrating goals-based planning. For some investors, investing is all about the returns. Goals-based planning takes the focus off returns, and instead places it on the client’s goals. In this approach, clients can enjoy a feeling of success when they achieve what they set out to do, such as retiring comfortably, paying for a child’s education, and the like. A goals-based mindset allows us to keep our perspective during volatile markets and can keep anxious investors from trying to time the market.
- Implementing a systematic process. Having a process requires discipline, and investors are better equipped to apply discipline during episodes of market volatility if their expectations are realistic, long-term, and if they understand why some investments have higher expected returns. Being systematic in your approach creates reliability and minimizes surprises.
- Staying calm. We’ve seen many crises affect stock prices over the years – not the least of which occurred during March of 2020, when the markets tanked over COVID news. Just as consistently, however, we’ve seen the markets reward disciplined investors. Reacting to a crisis by leaving the market is just another form of market timing. Market timing requires you to be right twice – when you choose the time to leave the market, and when you choose to get back in.
- Increasing portfolio diversification. Approximately half of the global opportunity set in stocks exists outside the U.S. The other half includes developed ex-U.S. and emerging markets. Because there’s no predictable pattern of the best-performing countries or asset classes, it’s impossible to identify in advance which will come out on top. In addition, there may be extreme differences between the best performers and the worst. We believe maintaining a diversified portfolio can help you avoid the highest highs and the lowest lows and help your investments stay on an even keel.
The world has experienced many crises and we will no doubt experience many more. Focusing on what we can control – such as keeping our emotions and our behaviors in check and tuning out the headlines – can help us all relax, focus, and work toward a better investment experience.