Why unconscious biases could ruin your chances of a comfortable retirementBack
No one likes to think of themselves as biased, but we’re all guilty of holding beliefs that aren’t based on actual facts. When it comes to investing, biases can be very detrimental. If you let your emotions get the better of you, your portfolio could suffer and you might not be able to afford the retirement you desire.
You might think your investments are based on cold, hard facts, but it’s highly likely your past experiences and perceptions influence your financial decision-making to some degree.
From following the herd to sticking with the familiar, here are four unconscious biases that could cost you dearly.
1. Herd mentality can encourage investors to try to time the market
Human instinct is to follow the herd, and this is especially the case when it comes to investing.
If everyone suddenly starts buying a particular investment, you might suffer from the ‘fear of missing out’ – or FOMO as it’s known colloquially. Likewise, if everyone starts panic selling, it would probably take every fibre of your being not to join in and sell your investments. Since neither decision is based on your own analysis or hard facts, you would have fallen victim to herd mentality.
Throughout history, herd instinct has caused investors a lot of heartache. In the late 1990s, investors poured enormous quantities of money into the dot-com sector, even though many businesses had questionable business models. No one wanted to miss out on ‘the next big thing’. Unfortunately, many internet companies crashed, leaving investors with significant losses.
In March 2020, when the stock markets started falling, lots of investors sold their shares in a panic and then missed out on the market’s subsequent gains.
Herd mentality often encourages investors to try to time the market, which is a risky strategy. Research by Schroders shows if you invested £1,000 in the FTSE 250 in 1989 and left it alone for 30 years, it might have been worth £26,831 by the end of 2019.
However, if you tried to time the market and ended up missing its 30 best days, you’d have ended up with only £7,543 – that’s £19,288 less.
2. Loss aversion could mean you miss out on investment growth
For some investors, their fear of making a loss is so great they don’t want to take on any investment risk. The problem with loss aversion is you could miss out on investment growth and your money might not keep up with inflation.
If you keep your money in cash, the chance of losing your capital is almost zero. However, interest rates on cash savings accounts are generally lower than the rate of inflation. Over time, your money could lose value in real terms.
According to the Bank of England, goods and services costing £10 in the year 2000 would cost £16.96 in 2019. Unless your money grew by an average of 2.8% a year, it would have lost its purchasing power.
When you invest in the stock market, there’s a risk your investments will fall in value. However, history shows that by investing for the long term, your money will hopefully have time to recover from market falls.
The Barclays Equity Gilt Study 2019 shows that since 1989, UK shares outperformed cash for two consecutive years in 81 out of the 118 periods studied. The probability of equities beating cash over two years in a row is therefore 69%, however, by extending the holding period to ten years, the probability increases to 91%.
3. Familiarity bias could result in lack of diversification
Most investors understand the importance of spreading their money across different assets, such as shares, bonds, property and cash. There are other ways of diversifying too, including by sector, region and company size.
You might feel wary about investing in companies that aren’t based in the UK. You’re familiar with the UK and so you’re comfortable putting your money in British shares and bonds. The problem with this approach is your portfolio’s performance could be entirely dependent on the fate of the UK economy.
Stocks and bonds in other parts of the world, such as the US, Europe and Asia, might not be affected by volatility in the UK. So, by investing in other regions, you could minimise the impact of British economic woes on your portfolio.
4. Confirmation bias makes people ignore important information
Confirmation bias is when you give more weight to information that supports your beliefs and less weight to information that disproves them. So, if you believe Company X is a sure-fire winner, you’ll pay close attention to news reports and analyses that back your opinion. If a new piece of research casts doubt over the future of Company X, you might disregard it.
As an investor, confirmation bias can result in poor decision-making. By ignoring information that contradicts your beliefs, you could hold on to a declining investment for much longer than if you’d given equal weight to all the evidence.
Overcoming confirmation bias is difficult because it’s human instinct to want to be right. To keep it in check, you need to actively search for information with alternative opinions to your own, especially if it’s about an investment you’ve come to cherish.
As legendary investor Warren Buffet once noted: “Charles Darwin used to say that whenever he ran into something that contradicted a conclusion he cherished, he was obliged to write the new finding down within 30 minutes. Otherwise, his mind would work to reject the discordant information, much as the body rejects transplants.”
A financial planner can help you overcome unconscious biases
If you’re worried about the impact of unconscious biases on your portfolio, a financial planner can help. A financial planner doesn’t just manage your money; they can also act as a behavioural coach to ensure your emotions don’t derail your financial goals.
At Holborn Financial, we’ll help you create a solid financial plan, ensure you have an appropriate asset allocation, and check your goals are on track. By sticking to your financial plan, you’re more likely to secure the retirement you’ve always dreamed of.
Get in touch
If you’d like more information on how we can help you achieve your retirement goals, email firstname.lastname@example.org or call 020 8946 8186.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.