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Financial Planning > Behavioral Finance

3 Behavioral Biases That Hurt Investors: Daniel Crosby

By Ginger Szala

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What makes us strong as human beings makes us weak money managers, said Daniel Crosby, Ph.D., president of Nocturne Capital, whose “The Futures is Behavioral” keynote opened the Financial Planning Association in Chicago on Wednesday. He added that fear is hard-wired into the human — and animal — brain, and we have an affinity to be loss averse.

“In the financial markets, what we think we ought to do and what we do are different,” he said. “In times of financial stress people lose 13% of their IQ.”

Further, he noted that “the body has a huge impact on how we make all decisions, including financial decisions.”

He added that we also reason collectively, in which our brain’s sensation and perception area can be changed to see what the collective believes.

“The body is weak, brain is old and outdated, and society ‘truth’ isn’t absolute truth but is what we agree on,” he said. “This impinges on our financial decision making.”

He says there are common behavioral errors that affect our clients’ thinking. These include:

1. Overconfidence or ego: People are especially more positive as a defense factor, he said, especially men, who when surveyed, thought themselves friendlier, funnier and better looking than average. Crosby said the researchers concluded that “the average man seems to think he is two sit-ups away from dating a supermodel.”

Ways investment advisors could deal with this include diversification within and between asset classes, building strong arguments, determining what usually happens and applying it to reality, and finding out what’s likely to be the weak link.

2. Conservatism: Typically we stick with what we what we know. “We have a tendency to stay with what’s worked in past,” Crosby said. “If I know what to expect, it will hurt less.”

How advisors can apply this: Buy what you don’t know, don’t know what you own, and procrastinate a little — e.g. people who sleep on a decision usually moved forward. Typically, he said, we overlook the powerful solutions because we look for the complicated solution.

“People try to game the system,” Crosby said. “But we need to put probability first.”

3. Emotion: People tend not to ask the sophisticated question. “We don’t ask if something is risky, but rather, is it fun?” He recommends overcoming emotion though meditation, or actually using emotion in a positive way.

He says that clients expect the advisor of the future to have a high IQ or at least be competent, have a good bedside manner, be able to customize portfolios, have access through technology, be able to communicate one-on-one, and most of all, give them peace of mind.

— Related on ThinkAdvisor:

Ginger Szala

@gingerszalaink

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