Make better investment choices by understanding and reducing bias.
Jeff Horne - Sep 19, 2022
Investors are often subject to behavioural biases that can lead to flawed decisions and choices. Being aware of these biases – and understanding how they arise from your background and life experiences – can help you make better investing decisions and achieve your financial goals.
Market movements and bias
It would be nice if our investments grew at a steady, predictable rate over the long term. Unfortunately, markets go up, go down and sometimes stay relatively unchanged. How savers and investors react to these changes depends considerably on the investment approach they choose. A recent quantitative analysis examined why many investors do not achieve the investment returns they expect, and noted that investment results depend more on investor behaviour than on the way their funds perform. Benjamin Graham, an investor and professor of finance who influenced the investment strategies of Sir John Templeton, Charlie Munger and Warren Buffet, said that the investor’s chief problem – and even his worst enemy – is likely to be himself.
Overcome bias by a portfolio approach
Adopting a portfolio approach to investing is one way to address these biases. A portfolio approach spreads investments out over a number of areas, so that you don’t have all of your eggs in one basket. Risk is reduced through a more diversified portfolio, and owning a greater variety of securities helps to reduce attention bias. Home bias can also be reduced by specifically including regional representation beyond locally known companies. Disposition bias is addressed by looking at how the portfolio functions as a whole so that selling a single poor-performing security is less of a concern.
Follow a wealth planning strategy
The many reasons why we choose to invest our savings are very personal. We often invest to be able to afford a comfortable retirement lifestyle. We also invest for goals such as home improvement, buying a car, a special vacation or to help children or grandchildren attend college or university. Including all of your goals in a well-constructed wealth plan allows you to have a better idea of how much you should save, and how your investment choices can affect how these funds can grow. Depending on your current investments and your ability to save, your financial goals may be on the right track or have already been attained by following your wealth plan. When this happens, the need to earn a specific return may be reduced, allowing the focus to shift from actively seeking growth to risk reduction in order to preserve your investments for your long-term personal goals. A wealth plan is designed to balance your ability to save with the investments that you make to achieve your personal goals. While the return that you earn on your investment portfolio is always important, investing is the means to achieving your goals, and returns should not be the goal itself. Focus on your long-term personal goals, rather than the regular movements of your investments. When a plan is on track it is easier to be more confident about your financial future.
Working with a financial professional is a great way to reduce the negative impact that personal biases can have on your investment portfolio and your ability to reach your personal financial goals. Furthermore, working with a financial professional and having a plan can prevent some of those biases from creeping in when information is complex or decisions involve risk or uncertainty.
Reducing the impact of your personal biases is an important part of achieving a better risk-reward balance when it comes to saving and investing for your future. Contact me today to learn how saving and investing can help you achieve your personal financial goals.