“I just got my annual bonus – let’s go on vacation!”
“It was so obvious that the dotcom and housing bubbles would cause bear markets. Everyone saw that coming!”
“Based on that information, let’s adjust our expectations a bit higher – but still consider our original estimate.”
“Those sound like good changes to our financial plan, but why change anything? Everything is going fine with our current plan right now.”
Do any of these sound familiar? Keep reading to learn which of these biases you may be unintentionally exhibiting.
Traditional finance assumes all market participants act as ‘rational economic persons.’ While all of our own decisions are perfectly rational (there’s that overconfidence bias!), we know that many others do not always make rational decisions. For investors, it is important to understand, detect, and confront your own behavioral biases. Behavioral biases are classified into two categories: cognitive errors and emotional biases.
Cognitive errors are driven by informational deficiencies or faulty memory. Cognitive errors may cause investors to unconsciously tilt away from decisions that cause temporary distress in spite of the long-term evidence. Fortunately, cognitive errors can often be avoided, or at least mitigated, by seeking better information and qualified advice.
Emotional biases emerge from personal feelings that are often deeply rooted in past experiences. Unlike cognitive errors, emotional biases cannot necessarily be corrected with “the right answer.” By asking the right questions, an advisor can adjust a financial plan to increase the odds of success.
Research from Vanguard, Russell Investments, and Morningstar estimate that an advisor’s behavioral coaching alone may be worth anywhere between 0.5% - 2.0% of value per year. Less discussed than a comprehensive financial plan or optimized asset allocation; working with an advisor can provide significant value through the mistakes you don’t make as a result of behavioral coaching!
Are You Exhibiting Any of These Biases?
“I just got my annual bonus – let’s go on vacation!” Mental accounting bias
“It was so obvious that the dotcom and housing bubbles would cause bear markets. Everyone saw that coming!” Hindsight bias
“Based on that information, let’s adjust our expectations a bit higher – but still consider our original estimate." Anchoring bias
“Those sound like good changes to our financial plan, but why change anything? Everything is going fine with our current plan right now.” Regret aversion bias
Economic and Market Commentary
Read our latest Economic and Market Commentary for Market Returns Year-To-Date, Market Returns Longer Term Annualized, Economic Indicators, and an Appendix.
Sources: Russell Investments' "2017 Value of a Financial Advisor Update", Morningstar's 2017 "The Value of a Gamma-Efficient Portfolio", and Vanguard's 2014 "Putting a Value on Your Value: Quantifying Vanguard's Advisor's Alpha."
This is intended for informational purposes only and should not be construed as legal, investment or financial advice. Please consult your legal, investment and financial professionals regarding your specific circumstances