Emotional biases are your worst enemy when it comes to investing
We humans are indeed a very strange and complicated species. Logical thought processes have ensured the continuous and incremental advancement of human kind, yet we are often so reliant on our instincts in our fight for survival.
This conflict between logic and survival instincts can also be seen when it comes to investing and we are all vulnerable, but only if these biases are not managed well. Although investing is a logical discipline, it is our innate survival instincts that often present our greatest challenge.
To give context to my statement, it is true that many of our actions are based on feelings instead of facts. Investors make investment decisions based on various emotional biases, which may have a real detrimental effect on the investment return, thus achieving exactly the opposite of what we want to achieve – inflation-beating returns.
So what is an emotional bias? Say, for example, a punter asks you to give him R100 to bet on a horse at the racetracks. The punter returns one day later and hands you R300, which means he has tripled your money – a phenomenal 300% return in just one day. So you give him back the R300 and ask him to bet your money again. The next day he returns and very apologetically gives you back only R150. You are furious since he has lost 50% of your money. But is your outrage justified? Because technically he made a 50% return on your money in just two days!
This is a typical example of how human emotions can quickly override logic. It even has a NAME since so many investors suffers from the same bias! It is called LOSS AVERSION, and the rationale is that we’d rather avoid losses than reap rewards. As investors, we hate losing our money. In fact, we regret our losses more than we enjoy our gains!
However, as mentioned above, if these biases are managed well we can be sure of reaping the benefits of responsible investing. And this is why the goals-based financial process, underpinned by sound investment strategies, is gaining worldwide popularity among financial planners.
The goals-based financial planning process lends itself efficiently to logical investment principles, and through meaningful educational discussions with a client, financial planners can help their clients understand and counter these biases and provide them with a value-added financial planning service.
In a webinar presented by Errol Meyer and Albert Louw, they will provide examples of these biases and also solutions for managing these investment destructive emotions.