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A keen awareness of behavioural biases plays a huge role in investment success. Here, we highlight the main types investors must be on their guard against.

Most people would like to think they are entirely rational investors. But the fact is we are all influenced by the psychological traits and (potentially irrational) beliefs that make us who we are. We don’t stop being human just because we are investing.

The key to more successful investing is to have an awareness of the behavioural biases that might be affecting your thinking. Addressing these to bring investors back to a more rational course is one of a wealth manager’s most important duties. A seasoned adviser who has seen it all before is invaluable in heading off expensive mistakes – and encouraging us to take opportunities.

Thus, the role of the wealth manager is more holistic (and potentially more life-changing) than many people realise. “We see ourselves as ‘wealth coaches’ for want of a better term,” says Allie Kirk, a Private Banker at Nedbank Private Wealth. “As we have become more familiar with the profession of life coaches, so private clients find they need help and guidance in their financial affairs.”

Types of behavioural bias

Whether you have an adviser or are bravely still going it alone as an investor, understanding behavioural biases can be very illuminating indeed.

Behavioural biases are broadly divided into emotional and cognitive types. With the former, emotions cloud our judgement; with the latter, our way of thinking about information is flawed. Both can be incredibly dangerous.

Which of the following do you have a tendency towards?

Emotional biases

  • Loss-aversion stems from the fact that we tend to feel the pain of losses twice as much as commensurate gains, and so act irrationally to avoid them.
  • The endowment effect is where you tend to value something you already own over something you don’t.
  • Status quo bias is where people miss out on opportunities (or fail to tackle problems) due to the illusory comfort of keeping things the same.
  • Self-control bias is where investors fail to stick to (what should be) a well-thought-out strategy, by falling prey to panic or exuberance.
  • Over-confidence bias sees investors overestimate the power of their abilities, knowledge of “gut feelings”.

Cognitive biases

  • Confirmation bias means that we give additional weight to (or seek out) information confirming what we already think.
  • Representative bias refers to our judging matters on their appearance (often in the service of other biases).
  • Framing bias is how people judge information on the basis of its presentation (how it is framed).
  • Self-attribution bias involves attributing good outcomes to our own wisdom and discounting other factors like luck
  • Anchoring bias is where we rely unduly on the first piece of information that struck us as our reference point.

A heady brew of biases

That was just a very small sample of all the cognitive and emotional biases that might be in play. Many appear in tandem or lead to another, making for a potentially toxic mix affecting your decision-making – and all without you having much conscious awareness.

Loss aversion can be particularly damaging as it often prevents people from taking on the reasonable level of investment risk they need to achieve their goals.

Confirmation bias is another big — and insidious threat — particularly because much of the swirl of articles, investment commentaries and posts we read each day are targeted to us on the basis of what we’ve read before.

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Top Tip

Your financial personality is as much a part of your profile as your assets and objectives. The problem is, people are notoriously bad at assessing themselves, even with digital tools. Talking your wealth situation through with a professional will reveal exceptionally useful insights, and those initial conversations can be arranged by us free and with no obligation at all. Take advantage!

Lee Goggin - Co-Founder

Lee Goggin


Manage loss-aversion

Crises bring out the best, and worst, in us. It is natural that these unprecedented times are magnifying any biases investors had (and making them fall prey to new ones).

The loss-averse will often retreat to cash in times of turmoil, little appreciating that how rapidly inflation can erode away its value and that there may actually be great opportunities in volatility. All investment decisions have to be rooted in your risk-profile and objectives. And, although your psychological comfort level is certainly important, analysis not raw emotion should rule your decisions.

Panic is a powerful – and potentially highly destructive force. “The most common error I come across is clients believing that reducing risk once the markets have fallen can help them sleep at night as they have done ‘something’ to protect their wealth,” says Colin MacKenzie, Director, Investment Management, at Arbuthnot Latham & Co., Limited. “That ‘something’ can easily have a lasting effect on their wealth, both positive and negative.”

Like others, Alan Noik, Managing Director at Credo Wealth, has seen the crisis prompt calls from several panicked clients wanting to “throw in the towel” on their investments and move into cash. Here, firms swing into action with a measured response that potentially involves re-running risk-profiling parameters.

Noik says: “At this juncture it was important to reassess two things: firstly, the client’s existing asset allocation and whether it still fits into their medium to long-term objectives, and secondly their appetite for risk.

“Clients who had previously thought they had a far higher appetite for risk (in a rising bull market) now found themselves reconsidering if they do, in fact, have that same appetite in a tumbling bear market environment. There is no right or wrong answer as these responses are highly personal to each client. Our job, as experienced wealth managers, is to have that discussion with our clients, unpack the various scenarios for them and guide them to the decision that is best for each individual.”

Cancel out confirmation bias

Like many bankers, Nedbank Private Wealth’s Allie Kirk says that people’s tendency to seek information aligned with their views means confirmation bias is one of the most common biases she encounters. A client may believe, for instance, that gold is a safe haven asset that does well in volatile times and this notion could become unhelpfully entrenched without a professional helping them unpick the evidence.

She explains: “To tackle this, we often ask the client to explain what information might weaken their view (e.g. the value of gold dropped by 4.5% on Friday 13 March – its biggest decline since 1983 – and so it doesn’t always do well in volatile times). We can also ask the client to imagine a scenario where they think through an argument that goes against their point of view, and then ask them to explain why.

“Using my gold example again, the precious metal is not easy to value using any of the normal valuation methodologies. This means that there are multiple opinions as to its value e.g. if US$1,500 per ounce is good value, would US$1,250 still represent good value? The client can often then see that not being able to accurately value an investment means it is difficult to know when to buy or sell, and perhaps shouldn’t be included in a portfolio.”

As our experts observe, although you should certainly get on well with your adviser, you need one who is unafraid to take the completely opposite side in your best interests, rather than always saying “yes”. As Christian Armbruester, Chief Investment Officer at Blu Family Office, notes: “People tend to do business with people they like, and they tend to like people who tell them what they want to hear.”

Nor should you let your feelings about an adviser or firm obscure their objective performance; you must keep reviewing how good a job they are doing for you. “Trust is good, but control is better,” Armbruester continues. “Always make sure that your service provider does what they say they were going to do.”

It’s good to talk

Unchecked, behavioural biases are a big threat to reaching your financial goals. It can actually be very empowering to recognise that one (or several) may be affecting your investment thinking, and even more so to talk them through with a professional. They can offer great comfort, boost confidence and be a vital counterpoint to all the market “noise” you may hear. As Noik says: “It’s at times like this that clients need to be able to pick up the phone and speak to their adviser. And that’s where experienced wealth managers can add an enormous amount of value.”

“For a long-term investor, time in the market can have a greater impact on results than timingthe market: sticking to a suitable level of risk through periods of both welcome gains and painful losses, should deliver acceptable returns over the long term,” adds MacKenzie. “Advisers can help clients stay the course.”

If you are a DIY investor with a dawning appreciation of the self-defeating biases that might be at work in your investment strategy, you can get an expert second opinion through us with no obligation. Or, if you feel your existing adviser isn’t doing enough to tackle your concerns, our expert team is standing by to offer objective advice.