Are you biased? No of course not. But then you would say that, wouldn’t you?
It may come as a surprise (or maybe not – we’ll get to not addressing things we don’t want to think about later) but we’re all susceptible to bias from time to time.
There are many types of bias and they’re hard-wired into us. From an evolutionary point of view they’re often very helpful – in life or death situations it can be useful for our brains to filter out all but the need-to-know information. But modern life comes with situations that these biases are ill suited to. In some cases, they can be dangerous and that’s rarely more apparent than when it comes to their effect on our investment decisions.
As investors, biases cause us to behave counter-intuitively – we leap before we look, we stay when we should go, we cringe at the risks that could generate our greatest rewards. We can identify 17 individual types of bias that close off our decision-making processes to information that could actually be really important.
But don’t worry – there are things we can do. A good first step is to understand each bias, what it can lead to and how it manifests itself, so we can spot it. In this series of articles, we’ll introduce each bias, explaining what it is and how it could play out in your financial decisions. Forewarned is forearmed.
Behavioural Bias #1 – Anchoring
Anchoring bias occurs when you fix on or ‘anchor’ your decisions to a reference point. It’s helpful in some situations, for example, if you’ve set a 10pm curfew for your son or daughter and it’s now 9:55pm, they’d be wise to panic a bit and step up the homeward pace.
But it’s only helpful where that anchor point is relevant and valid. For example, the following investment thought pattern might sound familiar:
“I paid £11 per share for this stock and now it’s only worth £9 per share. I’ll hold off selling it until I’ve broken even.”
Read in isolation, that idea may seem sensible. That’s why it’s dangerous – it’s a narrow thought process that leaves aside context. People often anchor on the price they paid when deciding whether to sell or hold a security, but evidence-based investing tells us the best time to sell a holding is when it’s no longer serving your ideal total portfolio, as prescribed by your investment plans.
What you paid is irrelevant to that decision, so anchoring on that arbitrary point creates a dangerous distraction – one which, to continue the maritime theme, could see you clinging to a sinking ship. If you must anchor to something, then anchor to investing in a solid plan – build your trading activities into a carefully constructed strategy, with predetermined asset allocations that reflect your personal goals and risk tolerances.
It may feel at times less like an anchor and more like being lashed to the mast by your crew to help you avoid the deadly lure of the Sirens, but you’ll stand a much better chance of overcoming the bias-driven distractions that rock your resolve along the way.
Next week we’ll talk about your blind spot…
Keep bias at bay
It’s surprising how hard it can be to simply let things be. Knowing why we react in the ways we do is the first step to avoiding the counterintuitive actions that can damage what we set out to achieve with our investments.
You can download Making Better Decisions: Know Your Behavioural Biases in full today.
If you’d rather read the report in bite-sized chunks, we’ll be posting the lowdown on each type of bias, how it works and why it’s dangerous on our blog in the coming weeks, or you can opt in to email updates.
Co-Founder & Director
Metis Ireland Financial Planning Ltd t/a Metis Ireland is regulated by the Central Bank of Ireland.
All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice. You should always engage the services of a fully qualified independent financial adviser before entering any financial contract. Metis Ireland Financial Planning Ltd t/a Metis Ireland will not be held responsible for any actions taken as a result of reading these blog posts.