Nancy Graham March 5, 2019 Behavioural Finance Personal Wealth A Hit List of the Six Most Unwanted Behavioural Biases Remember that famous line from crime boss Michael Corleone in “The Godfather” series? Keep your friends close, but your enemies closer. Go ahead. Give yourself a big bear hug. To paraphrase a financial godfather of sorts, Benjamin Graham, YOU are usually your own worst enemy as an investor. Why is that? Even though every investor wants to buy low and sell high, we’re all subject to financial behavioural biases that stand in our way. To find out more, you can read on, or check out my “No Dumb Questions” video version, whichever you prefer. To Err Is Human Are you a human being? If so, you’re biased. In one of his “Globe and Mail” guest columns, my PWL Capital colleague Dan Bortolotti called them “a burden from which humans will never be entirely free.” Don’t worry too much. That’s not always a bad thing. Without the “fight or flight” instincts that drive our many biases, we may never have survived as a species. Your behavioural biases still keep you from running red lights. They make sure you spring into action if you hear a child scream. They keep us mostly upbeat and optimistic during the daily grind. All good things. But those same biases can cause serious damage to you as an investor. So today, let’s look at a hit list of the six most unwanted financial behavioural biases that stand between you and your most rational investing. Hopefully, by being aware of them, you can overcome them. Since we humans love patterns, I’ll go alphabetically, starting with ANCHORING BIAS. This occurs when you “anchor” your investments to an arbitrary reference, such as the price paid. During down markets, you tend to want to wait until you at least “break even.” Instead the best time to sell a holding is when it no longer fits your plans, not at some random break-even point. Anchors aweigh! Then, there’s FEAR and GREED, both firing off deep in your brain, long before higher reason kicks in. Fleeing scary markets and chasing hot run-ups causes investors to buy when stocks are expensive and sell when they’re cheap – even though we know better. These behaviours are so ingrained, “Behavior Gap” author Carl Richards has made a famous drawing of them. OVERCONFIDENCE puffs up your belief that YOU have what it takes to beat the market. In reality, when it’s you, betting against trillions of global dollars at play, you’re better off patiently participating in the market’s expected returns, instead of going for broke – potentially literally. As I mentioned earlier, we humans crave PATTERN RECOGNITION … even when there isn’t any. For example, flipping a dozen consecutive heads in a coin toss may seem like a telling pattern, but we all know it still tells you nothing about the next toss. By mistaking similar, random market runs as predictive patterns, investors are often left chasing expensive mirages. Even though the Toronto Stock Exchange is over 150 years old, RECENCY tricks us into basing most of our trades on what’s happened lately. By fixating on recent returns, investors again end up chasing high prices, and panicking during the downturns, instead of resolving to go the distance. Finally, there’s TRACKING-ERROR REGRET. I’ve already covered this one in my video, “Have You Caught Investment Envy?” As I said then: Other people’s winning ventures may be fine for them, but they may be an awful idea for you. Your best bet remains the same: Have a plan of your own, compare it now and then to appropriate benchmarks, and stick with it over time. No regrets! Whew! That was a lot of behavioural biases to take in all at once. Before we wrap, here’s one behaviour I do endorse: Go ahead and subscribe to my “No Dumb Questions” YouTube channel. If you ask me, it’s one “hit list” worth following. Share: Facebook Twitter LinkedIn Email IIROC AdvisorReport