Introduction to the ABCs of Behavioral Biases

Introduction to the ABCs of Behavioral Biases

“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 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 stay when we should go. 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 more efficiently and act more effectively in our busy lives.

Usually (but not always!), these shortcuts work well for us. They can be powerful allies when we encounter physical threats that demand reflexive reactions, or even when we are simply trying to stay afloat in the rush of deliberations and decisions we face every day.

What Do They Do To Us?

As we will cover in this series, those same survival-driven instincts that can otherwise be so helpful can turn on us as investors. 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 they are there, you will probably still experience them. It is what your brain does with the chemically induced instincts that fire off in your head 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 “Petrie dish of financially pathologic behavior,” including:

  • Counterproductive trading: We incur more trading expenses than are necessary, buying when prices are high and selling when they are low.
  • Excessive risk-taking: We reject the “risk insurance” that global diversification provides, instead over-concentrating in recent winners and abandoning recent losers.
  • Favoring emotions over evidence: We disregard decades of evidence-based advice on investment best practices and instead let our “gut” be our primary guide.

What Can We Do About Them?

In this multipart ABCs of Behavioral Biases Series, we will offer an alphabetic introduction to investors’ most damaging behavioral biases, so you can more readily recognize and defend against them the next time they are happening to you.

Here are a few additional ways you can defend against the behaviorally biased enemy within:

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 will stand a much better chance of overcoming the bias-driven distractions that rock your resolve along the way.

Increase your understanding. Do not just take our word for it. Here is an entertaining and informative library on the fascinating relationship between your mind and your money:

Do not go at it alone. Just as you cannot see your face without the benefit of a mirror, your brain has a difficult time with “seeing” its own biases. Having an objective advisor is among your strongest defenses against all of the biases we will present throughout the rest of this series. Look for an alliance who is well-versed in behavioral finance, dedicated to serving your highest financial interests, and unafraid to show you what you cannot see for yourself.

As you learn and explore, we hope you will discover that you may be unable to prevent your behavioral biases from staging attacks on your financial resolve. But, forewarned is forearmed. You stand a much better chance of thwarting them once you know they are there!

In our next piece, we will begin our A to Z introduction to many of the most common behavioral biases.

FREE FINANCIAL ASSESSMENT

With all the uncertainty and volatility in today’s economy, the time is now to take a thorough look at your finances. To accurately plan for your financial future, you must first know where you currently stand. For these reasons, our Success Team at Impact Advisors Group is offering a free financial assessment for both individuals and business owners. Request yours today!

This post was written and first distributed by The Writing Company.

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