Imagine you’re walking down the street on a warm, sunny day. Out of the corner of your eye, blowing in the wind, you spot a piece of paper. As you squint your eyes to get a better look–you realize it’s a $100 bill! What luck!
Here’s the core question of behavioral finance: do you
Go splurge on a lobster dinner from the best restaurant in town or Count your lucky stars that you have an extra $100, and invest it wisely?
Although this is a fairly simple example, it speaks to the small decisions that we make that end up becoming the foundation of our financial futures.
What is Behavioral Bias in Finance?
Behavioral finance is looking at psychological factors that influence investor decisions in financial markets, and their interpretation of informational inputs.
There is a reason that most of the world’s richest people DON’T make their financial decisions on their own. Yes, even Warren Buffet has his partner Charlie Munger to bounce his investment decisions off of. That’s because even the greatest investors of all time are often victims of their behavioral biases.
A certified financial planner is your Charlie Munger. They can analyze your financial prospects from a completely neutral, and financially educated, point of view. A good certified financial planner knows what to look for in their clients’ behavioral biases and can help them steer clear of unwise financial decisions made based upon those biases.
In this article, I will talk about 3 common behavioural mental biases and how they affect your financial decision.
Loss Aversion
In a baseball game, the objective is to win, not to avoid losing. Too many investors base their investment decision on what is called Loss Aversion. If you play to NOT lose, you’ll lose.
Investing your money comes with a certain level of inherent risk. Every investor’s risk tolerance is their own decision to make, however being TOO risk averse can actually be incredibly detrimental to your portfolio. Doing things like stashing money in a savings account and watching it get eaten away by inflation, instead of investing that money–this is a recipe for failure.
How a CFP Can Help — A certified financial planner helps you make calculated risks and works to balance your portfolio with some investments that are slightly riskier, and some that are less so.
Anchoring Bias
This one has a bit of overlap with overconfidence bias, but is slightly different in how it can creep in. Anchoring bias is a tendency to overvalue a single piece of information, rather than looking at the entire, complex, investment scenario. Sound investments are made upon multiple pillars of information.
For instance, many investors will latch onto an early price target of theirs, causing them to hold onto a particular security for far too long, crushing their potential gains into the dirt.
How a CFP Can Help — A CFP takes the time to understand the multitude of angles before committing to an investment and will help you as an investor adapt your strategies to new information in a world that is constantly in flux.
Herd Behavior Bias
While we often feel a sense of safety following the herd, that doesn’t mean our money is safe doing so. Especially with the advent of trading apps for our smartphones, more and more investors are falling into the herd behavior trap, following their friends and coworkers into risky or foolhardy investment decisions.
There’s an old saying that really rings true: “If your friends jumped off a bridge, would you do it too?”
How a CFP Can Help — When you’ve been investing long enough, you begin to spot the weak points–which are often apparent–in the investment strategies of friends, family, and other acquaintances. A CFP can help you steer clear of these herd mentality landmines.
It’s Time to Get Serious
Knowing and understanding what biases might negatively impact our financial decisions is crucial to your development as an investor. What lies beyond them is a world of investment possibilities that your Certified Financial Planner can help you decipher–while prospering in any market conditions.
PEYMAN SALARI, CFP®
Senior Financial Advisor
Peyman Salari is a certified financial planner, entrepreneur and founder of Canadian WiseInvest™ Inc. He has loads of knowledge in financial planning, investment strategy and estate-planning. Peyman is the go-to financial expert for many business owners and Canadian families in 5 provinces. He’s trusted by his clients because of his knowledge, integrity and responsibility. His ultimate goal is to help others be financially successful; he accomplishes this by speaking his knowledge through articles and public appearances.
