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Hudson Financial Planning - Avoiding Behavioural Biases

Avoiding Behavourial Biases

“I can calculate the motion of heavenly bodies, but not the madness of people”

Sir Isaac Newton, in reference to the South Sea share collapse in 1720.

Just as how we have an instinct to flee from danger or brace for an impact, falling markets can cause an instinctive response to sell shares and get away from a seemingly bad situation. The difference with share investing however is that the reality of the danger is often already incorporated in to prices. It is best therefore to keep your emotions and biases under check when it comes to investment decisions.

There are many means by which behavourial bias can affect the way we handle our investments.

  • Having an affiliation with the product – this is perhaps more common in property investing where investors stick to the areas they are familiar with, justifying themselves by saying things like “I can keep an eye on it”. However the same can happen in share investing, with people being over-weight in an industry they are employed in, or a company they are a customer of.
    • Remain unbiased: remind yourself that better opportunities probably exist outside of what you have familiarity with, and that generally speaking companies do not reward loyalty.
  • Past experience – a loss in a certain industry or asset class can affect an investor’s willingness to invest there again.
    • Remain unbiased: remind yourself that a past failure does not mean a future one is inevitable. Similarly, a good past experience may be giving you a degree of overconfidence.
    • Don’t be influenced by past regrets. It is possible to make a good decision and get a bad outcome!
  • Finding a reason – if we have biases such as those above, human instinct can cause us to look for supporting facts to reinforce it.
    • Remain unbiased: Step back and look at the whole picture. Spend as much time seeking a reason not to make a decision, as you do trying to reinforce it.
  • The Media! It goes without saying that the main aim of any provider of the news is to sell the news. They have an incentive to make current events sound more earth shattering than they really are. They rely on emotions like greed, fear and anxiety.
    • Remain unbiased: Remember that although the news is “new”, it is not as current as the share market prices at any given time, i.e. whatever you are reading has probably already been factored in.

“Be fearful when others are greedy and greedy when others are fearful”

Warren Buffet. 2007.

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