Are hidden behavioural biases sabotaging your wealth?

Financial stress can have a considerable effect on your everyday well-being. Throughout the COVID pandemic, cases have been reported even more significantly as a result of financial uncertainty. Research confirms that one in three Australians are now reporting financial stress. Financial stress can be short-lived, often resulting from challenging events.

Financial anxiety on the other hand can be more severe and longer-lasting. It is defined as “an uneasy and unhealthy attitude toward engaging with your personal finances in an effective way.” Anxiety disorders can manifest themselves as unrealistic worries, compulsions and obsessions, and is caused by a combination of factors that can include prolonged financial distress.

Regardless of how knowledgeable we are, oftentimes we make financial decisions that are prepossessed by behavioural biases resulting in acting on emotion or sabotaging our ability to process information. This has resulted in a specialised field of study that combines psychological theory with conventional financial economics to craft more efficient financial strategies to supplement for human limitation.

In total, over 180 cognitive biases are influencing our critical thinking, perception, and reality, which are easily corrected (more so than emotional biases) via education, better information, and advice. The most common biases that are hazardous to your wealth and triggered when experiencing a higher level of stress than usual are:

Overconfidence bias: Investors participate in the market more frequently and fail to appropriately diversify their portfolios due to unwarranted faith in their intuitive reasoning. The overconfident investor overestimates their knowledge and abilities. The challenge here is to resist the urge to believe that their information and intuition are better than others in the market.

Status Quo: A tendency to do nothing to avoid experiencing change or the unknown, thus as an investor, we use our current state as the baseline and refuse to deviate from it. Minding that any deviation is perceived as a loss, stopping us from selling securities that underperform resulting in excessive risk or investing too conservatively.

Regret aversion: An emotional bias causing investors to challenge past decisions and to question their beliefs to eliminate the pain of regret associated with a bad decision. For example – I didn’t invest in the market in 2008 and the following bull market years and missed out on some exceptional returns. As a result, no action becomes the favourable conclusion.

Confirmation bias: Lures investors seeking evidence, proof that confirms their already existing convictions, and contrarily ignoring other information challenging or contradicting their views. Resulting in not acknowledging differing points of view, essentially missing out on opportunities in the market.

Click here to view other forms of Cognitive Biases.

“The investor’s chief problem – and even his worst enemy – is likely to be himself.”
Benjamin Graham

Which biases are you prone to? Recognition is the first step to overcoming the roadblock and trickery of our minds. At Alman Partners we believe that with appropriate support and financial education, we can assist you to reduce your financial stress and anxiety.

Veronika Holubova (MFinP, GradCertFP, ADFP, DipFP) is a representative of Alman Partners Pty Ltd, Australian Financial Services Licence No: 222107.

Note: This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

References:
https://busterbenson.com/piles/cognitive-biases/
https://bigthink.com/mind-brain/cognitive-bias-codex?rebelltitem=6#rebelltitem6

 

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