Also, increasing the timeframe and placing the emphasis on a long-term plan can help prevent the overconfident investor from over-trading based on short-term factors.
4 - Regret Aversion
Anticipating regret and envisioning the emotional discomfort of making a poor decision can result in inertia, where investors fail to act or stick with a default option for fear of making an active choice which later turns out to be sub-optimal.
Conversely, investors may make impulsive decisions with the fear of missing out on an opportunity.
How to recognise and how to avoid: Following a plan with a diversified portfolio focused on long-term investment goals will help investors regulate emotions and avoid succumbing to feelings of fear and regret.
It takes a realist to face up to losses, and therefore advisers need to confront their own behaviours and be open and transparent with clients – are the reasons for the drop in value short-term or are there wider issues at play?
As trusted professionals, advisers must encourage clients to stick to the plan, but be prepared to recommend action where client inertia could cause bigger problems
5 - Recency Bias
Investors evaluate the likelihood of future events on recent memories without putting them in perspective of the longer-term past. This often relates to information that is easily accessible and available which can lead to poor investment choices.
How to recognise and how to avoid: Older clients may traditionally be more sanguine than younger investors about sharp market falls, having lived through many of them over the years. However, the current situation is perhaps different, given the threats not only to the economy but to wider society and, indeed, the individual’s own health and well-being.
Just as fund managers tend to focus on the ‘fundamentals’ of their investment strategy, and view market movements through the perspective of whether or not it alters those fundamentals, so advisers have to encourage clients to focus on the ‘fundamentals’ of their long-term financial plan.
Only by doing this can they avoid short-term thinking which can lead to recency bias.
Summary
Research carried out by Dynamic Planner earlier this year supports previous studies by the likes of Vanguard, which demonstrated investors who worked alongside a financial planner were more resilient; had higher levels of positive emotions and self-esteem; were more confident in their abilities to manage their finances; more conscientious and emotionally stable; and were better able to regulate their emotions, than investors who attempted to go it alone.
This may be a reflection of the type of people who seek advice as opposed to a direct cause of receiving advice. Nonetheless, if advisers can make investors more aware of the powerful biases that can influence their attitudes and behaviour towards financial risk, they can also help them to manage their investment journey in a much more positive way.
