Why You’ll Never Make Great Investment Decisions Without a Financial Adviser
I’ve written on this subject in the past and expressed my opinion that you don’t need a financial adviser in the initial years when you’re trying to grow your savings.
That said, we all like to think that we have great instincts. What better instinct to have in today’s world than one for a good investment?
Take a moment to think about the money you could make.
The problem is that we all, including those working in the financial industry, hate to admit when we are wrong. As an investor, there could not be a more detrimental attitude to hold onto. Such stubbornness could have great implications for your wealth overnight. That is why it is imperative to have a Financial Adviser to help steer us in the right direction.
Otherwise, we are at the mercy of what H. Kent Baker and Victor Ricciardi call the ‘Eight biases’.
The Eight Biases
In Baker and Ricciardi’s study on behavioural finance, they suggest that there are eight biases which are a natural part of our human behaviour, which can negatively influence our investment decisions. The only way that we can shed ourselves of these biases is to increase our awareness of what they are and why we have them. The following is an outline of all eight:
1. Anchoring or Confirmation Bias
This first bias can be defined as first impressions. Good first impressions can sometimes be just as unhelpful as poor ones. All we are doing is filtering information that supports our own opinion, or in this case, our own bias, based purely on preconceived ideas that we hold. For example, if you hold the steadfast idea that a financial broker is greedy, then you will most likely continuously search for signs that you are correct if you are ever seeking advice from one. After all, we all like confirmation that we are right.
2. Regret Aversion Bias
This prejudice relates to those who are afraid of making the same mistake twice. They will rarely if ever, take a risk which can be the most detrimental bias you can hold as an investor because your success is all about taking risks; albeit calculated ones. Regret aversion bias can go as far as an investor refusing to let go of an under-performing investment because they do not want to admit that they’ve made a poor decision.
3. Disposition Effect Bias
The above refers to investors who view some investments as sure winners and others as certain losers. They have a tendency to cling to their investments even if they’re doing poorly. This is partly out of denial that they have made a poor decision and partly in the belief that in the end, it will come through for them. On the flip side, they can sell a winning investment through the assertion it will lose.
4. Hindsight Bias
The hindsight bias leads to investors thinking that a certain past event was inevitable. They may even find preconceived facts to back up their claims even though to most observers the event was as indiscriminate as most investment failures and success tend to be. The problem really occurs, however, when the investor starts to make investments, based on his hindsight bias. The investor may even look for early signs that the investment will go the same way as one in the past.
5. Familiarity Bias
Familiarity bias is when as an investor makes investments that are well known to him or just familiar to people in general. Even when there are serious financial advantages to be had from diversification, they will continue investing in familiar markets. Ironically, what they view as risk-free investing can lead to high risk.
Overall, it is much more profitable, and some would say safer, to invest in both well-known and lesser-known markets. For a start, it gives you a broader understanding of the opportunities that are available to you and how to get them. What, for example, would happen if you held this bias and many of the more familiar markets collapse?
6. Self-attribution Bias
The aforementioned refers to those who attribute successful investments to themselves and unsuccessful investments to factors outwith their control. This prejudice can lead to a number of problems when investing. Firstly, people with this bias refuse to take even the soundest advice, claiming to trust completely in their own instincts. Secondly, as you can imagine, they can become overconfident in their approach, which can work in the short term but can lead to them making rash decisions in the future. How many people in the business world have you heard of, for example, crashing back down to Earth soon after making it big?
7. Trend-chasing Bias
Another bias which can come naturally for most people can be referred to as ‘jumping on the bandwagon’ in terms of chasing a trend. There are two examples of this. First is the tendency to follow what everyone else is doing; even when your instinct is telling you otherwise. Second is the tendency to chase trends based on their past performance. Unfortunately, past performance cannot always be a guide to the future. Some product issuers play on this bias by bigging up past performance in order to get investors on board. The secret, however, is always to play the present market.
The key here is to remember that there is a big difference between worry and anxiety. Worry is a normal state for just about anyone but the coolest of cucumbers. You can even say it acts as a defence mechanism against making bad mistakes. In fact, it is usually those who are over confident, that tend to make the biggest errors in judgement. Anxiety though is different. Anxiety is worry on steroids. Instead of encouraging you to ponder over your actions, it makes you avoid taking any action altogether. Let’s not forget that you will not reap advantageous returns as an investor if you are unwilling to take some degree of calculated risk.