By Phil Passaris

A lot of our decision making has been hard-wired into us since the beginning of mankind. To survive in a prehistoric world, our hunting and gathering forebears had to adopt a range of short-cuts or biases in their thinking. These short-cuts enabled them to make faster decisions based on limited information (and helped them to avoid being eaten).

How we make choices in stressful circumstances is a fascinating topic. How much does intelligent analysis determine our decision, and how often do innate biases play a role? That’s what a number of researchers are now trying to discover.

What seems to be emerging is a sense that some modes of thinking that served humans well in prehistoric times can be counterproductive in today’s financial jungle, particularly in times of market correction. Can these biases be overcome? It is possible. The first step to achieving that is recognising and understanding the main biases that can come into play.

Herding behaviour

People feel reassured when they are doing what others are doing. Unfortunately, when it comes to finances, following the crowd isn’t always a good idea. Often the crowd is too late. They’re reacting to what has happened, rather than what is likely to happen in the future.

“I read in the news that the market is down and that lots of people are getting early access to their super. Maybe I should too.”

One way to counter the effect of the crowd, is to turn down the telly and put down the phone. The volume of information flooding into our lives has never been so high, and it’s easy to feel overwhelmed. A constant barrage of bad news can make it difficult to see the light at the end of the tunnel. It can also stop you from recognising the opportunities that are in plain sight.

Hindsight bias

They say that hindsight is 20/20. And there’s certainly been a lot of hindsight in 2020.

How often have you heard people say something like:

“I knew I should have waited a little longer. I could have bought that investment for a much cheaper price.“

“I knew Covid-19 was going to turn into a global pandemic. I should have sold all of my investments in February. It was so obvious.”

There’s always perfect clarity looking back, but it’s never crystal clear looking forward. We need to accept that even the best investment analysts cannot predict the future, let alone have an understanding where markets will be short term, as this is mostly driven by sentiment. Unpredictable events remain just that, unpredictable. The focus on long term fundamentals, global thematics and understanding why you are investing in the first place are the keys to a successful investment strategy.

Confirmation bias

It’s natural for us to seek out opinions that are similar to our own. We see this happening quite a lot on social media. Each channel’s algorithm works out what we like and prioritises more of those things in our news feed. This can lead to an ‘echo chamber’ effect where our view of the world is constantly being reinforced and contrary views are rarely presented to us.

Even without artificial intelligence curating information for us, we can surround ourselves with ‘facts’ that confirm or strengthen our prior beliefs or hypotheses. Why is this bad for an investor? Well, it can narrow their view. They can start with a particular point of view and then start to seek out evidence that supports that perspective.

To help counter this, remember every trade has two sides. Assume the other side of the trade is as smart and as motivated as you are. Ask yourself, why is someone willing to sell you their shares at that given price? To minimise the risk of confirmation bias, attempt to play devil’s advocate. Challenge the status quo and seek information that causes you to question your investment thesis.

Loss-aversion

In behavioural economics, this is the preference to avoid losses more than acquire equivalent gains.

Put simply, the pain of losing $1,000 is more pronounced than the joy of making $1,000.

Clients spend years constructing a long-term investment strategy which is very outcomes-focused, but when the market corrects, all those well-laid plans can go out the window. Fear and panic sets in and the desire to avoid short term losses ultimately leads to adverse investment decisions based on short term thinking. It is critical that investors have a trusted adviser who can hold them accountable to their long-term strategy and help them navigate through turbulent markets.

As Mike Tyson so eloquently puts it – “everyone has a plan, until they get punched in the face”

Recency bias

We all have a tendency to more easily remember things that happened recently, versus longer ago. It can prompt us to place undue importance and weight on recent events. When we see our portfolio drop 10%, recency bias convinces us that it will just keep on dropping.

It is also evident when we experience a bear market such as the recent COVID-19 crisis. It is very easy to remember the recent downward trend and pain of the sell off, however the record setting bull markets of the last 10 years are just as easily forgotten.

To counter this, remember to maintain a bigger picture perspective and don’t act hastily based on recent events.

We all have biases. However, if we realise the influence they can have on our own thinking, we can improve the quality of our decision making. One way to overcome innate biases effects is to obtain external advice. Investing your own money is a very difficult thing to do. Uncertainties tend to cause us to lose sight of the long-term and focus on the immediate. We swap the telescope for a microscope, and our returns tend to suffer. Being able to emotionally detach from decisions and taking a longer-term perspective can help enormously.

At Elston we remain balanced and rational in our conversations regardless of the economic conditions and where the herd is seemingly leading us. Through our structured step by step process and ongoing education we help you understand what makes you tick and ultimately turn times of volatility into valuable opportunities.

If you would like more information please call 1300 ELSTON or contact us to speak to one of our advisers.