“The investor’s chief problem – and even his worst enemy – is likely to be himself.”
— Benjamin Graham (1894–1976)
Legendary economist and investor Benjamin Graham made his timeless observation decades ago, and yet still today it reflects our enduring belief: Your own behavioral biases are often the greatest threat to your financial well-being. As investors, we leap before we look. We go when we should stay. We cringe at the very risks that are expected to generate our greatest rewards. All the while, we rush into nearly every move, only to fret and regret them long after the deed is done.
Why Do We Have Behavioral Biases?
Most of the behavioral biases that influence your investment decisions come from myriad mental shortcuts we depend on to think and act more efficiently in our busy lives.
Usually these short-cuts work well for us. They can be powerful allies when we encounter physical threats that demand reflexive reaction, or even when we’re simply trying to wade through the thousands of decisions we face every day.
What Do They Do to Us?
Those same survival-driven instincts that are otherwise so helpful can wreak havoc on your investment plan. They overlap with one another, gang up on us, confuse us, and contribute to multiple levels of damage done.
Friend or foe, behavioral biases are a formidable force. Even once you know about them, you will still experience them; these are chemically induced instincts that occur long before your higher functions kick in. They trick us into wallowing in what financial author and neurologist William J. Bernstein, MD, PhD, describes as a “petri dish of financially pathologic behavior,” including:
- Counterproductive trading – incurring more trading expenses than are necessary, buying when prices are high, and selling when they are low.
- Excessive risk-taking – rejecting the “risk insurance” that global diversification provides, instead over-concentrating in recent winners and abandoning recent losers.
- Favoring emotions over evidence – disregarding decades of evidence-based advice on investment best practices.
What Can We Do About Them?
The trick is for us to more readily recognize and defend against them the next time these biases are threatening to affect your decisions. For your reference, here is our ABCs of Behavioral Biases, which will help you learn what these biases are and how they can both help and hurt you.
Anchor your investing in a solid plan – By anchoring your trading activities in a carefully constructed plan (with predetermined asset allocations that reflect your personal goals and risk tolerances), you’ll stand a much better chance of overcoming the bias-driven distractions that rock your resolve along the way.
Don’t go it alone – Just as you can’t see your face without the benefit of a mirror, your brain has a difficult time “seeing” its own biases. Having an objective advisor – well-versed in behavioral finance, dedicated to serving your highest financial interests, and unafraid to show you what you cannot see for yourself – is among your strongest defense against all of your biases.
You may be unable to prevent your behavioral biases from staging attacks on your financial resolve. But, forewarned is forearmed, and you stand a much better chance of thwarting them once you know they exist.
Emotions and News Consumption in the COVID era
Most of us were hard-pressed to find feel-good headlines during 2020, and while we have begun a new year with new hopes and a clean slate, COVID-19 still dominates our new cycles, fostering anxiety for many of us. Thoughtful, sober answers to our most pressing questions must now compete against a deluge of emotional misinformation that can be as virulent as the ailment itself.
While there’s nothing wrong with having emotions – even strong ones – our emotional reaction to unfolding news can have a significant impact on our financial well-being.
Grieving the Loss of “Normal”
For example, many of us may be grieving the loss of the “normal” life we used to have just a year ago. It’s important to acknowledge these feelings. In a National Public Radio piece from early in the pandemic, behavioral counselor Sonya Lott explained how unattended grief can impair “every aspect of our being – physically, cognitively, emotionally, spiritually …” and financially, we might add. Lott says, “We can’t heal what we don’t have an awareness of.”
In other words, emotions are not only unavoidable, they are also essential. But remember:
When you put your feelings in the financial driver’s seat, they will steer you toward what your instincts would prefer, rather than what reason might dictate.
Behavioral Finance and Emotional Investing
Behavioral finance is a field of study dedicated to understanding how our instincts and emotions often interfere with our ability to make rational financial decisions. Every investor faces strong, hardwired temptations to:
- Chase illusory trends.
- Fear the very investment risks that are expected to generate our greatest rewards.
- Regret even our most sensible decisions in the face of minor setbacks.
- Disregard the most durable data.
- Overreact to breaking news and dramatic language.
On that last point, words alone can create a potent brew of emotions. Triggering or politicized language probably generate a rise out of you, one way or the other. The same goes for financial catchwords like crashing, soaring, crisis, and opportunity.
Think of the recent media news storm around GameStop and the stories of Robinhood investors piling into easy returns with GameStop stock. The giddy euphoria surrounding the story led many to question whether investing by professionals or more traditional strategies were a loser’s game. Easy money was to be had with just a click of a few buttons. But the likelihood of making it rich, especially on any kind of a consistent basis, through get rich quick schemes and speculation is not a viable long-term plan. People went into the investment with little understanding of the dynamics of the market or the underlying fundamentals of the business they were buying; instead of caution and analysis they used simple thoughts of easy money egged on by greed. Like so many other past manias – think tulip bulbs or dot com stocks, these events rarely end well for most of the participants.
Strong feelings, while natural, will create cognitive blind spots in your reasoning. Add the speed and omnipresence of the Internet, and it becomes even easier to lead with your emotions.
Powering Past Your Emotions
Learning how to navigate past these and many other emotional traps is crucial. It can help to have an objective advisor point out your own behavioral blind spots, and you can help yourself as well.
Has something you’ve seen, heard, or read left you feeling anxious or restless? The more aggressively an appeal tugs at your emotions – in fear, anger, excitement, or elation – the more important it is to avoid being consumed by it.
Especially if it involves your financial well-being, we strongly recommend hitting the pause button before making any next move. Take your emotional “temperature.” Wait for the heat to subside. Most important, take some time to conduct extra due diligence before taking the bait.
Play the long game. Invest over time and with a consistency of purpose. While stock markets are volatile in the short term, their returns and outcomes become less so over time. A recent article in the New York Times pointed out that if you invested $10,000 in March 2000 (the peak of the dot com bubble and at a time when mania was in full flung glory), and you had just invested in a low-cost S&P 500 index fund and did nothing with it, your $10,000 would have turned into nearly $28,000 by the end of January 2020. That is a nearly 5% annual return after adjusting for inflation. And that is if you went in at exactly the worst point to enter the market in decades.
And, on average, if you were to select a month between 1990 and 2019 to begin investing, your annualized return through January 2021 would have been 9.8% after inflation. All you had to do was ignore the news and to just let it ride. These kinds of “bets” are rarely exciting, but they have a tendency of getting you to where you want to be in the long term. Avoid the emotion, reap the gains.
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David is a Certified Financial Planner, Wealth Advisor, and Partner at Willow Creek Wealth Management. Willow Creek is a fee-only financial planning firm in Sonoma County, CA serving clients throughout the San Francisco Bay Area and across the country. Willow Creek offers comprehensive financial planning encompassing investment management, retirement planning, tax planning, charitable giving, sustainable investing, and more.