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Financial Planning > Behavioral Finance

This Is the Biggest Behavioral Bias Driving Investment Mistakes, Advisors Say

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Behavioral biases are among the most common drivers of investment missteps. The most common culprit? Being easily influenced by recent news events or experiences, according to new research sponsored by Charles Schwab Investment Management (CSIM) in collaboration with the Investments & Wealth Institute.

That specific bias — dubbed “recency bias” — was cited by 35% of advisors polled for the BeFi Barometer 2019 survey as a behavioral bias affecting their clients’ investment decisions, the companies said Monday. It was followed by loss aversion bias (playing it safe or accepting less risk than can be tolerated), cited by 26% of advisors.

Rounding out the top five were confirmation bias (clients seeking information that reinforces their perceptions) at 25% and familiarity/home bias (a preference to invest in familiar, especially U.S.-based companies) and anchoring bias (a tendency to focus on specific reference points when making investment decisions) at 24% each.

But the survey results indicated that vulnerability to specific behavioral biases varies by client age. Advisors surveyed said they observed framing bias (making decisions based on the way information is presented) to be the most common bias among millennials, while recency bias was the top one among Generation X, anchoring bias was the top one among baby boomers and familiarity/home bias was the top one among the older silent generation.

For the study, more than 300 financial advisors were surveyed in July for CSIM and Investments & Wealth Institute by Cerulli Associates, the companies noted, adding those polled came from wirehouses, RIAs and national/regional broker-dealers.

Investors are often convinced that what happened yesterday will happen tomorrow, Scott Smith, director of advice relationships at Cerulli, noted during a briefing with reporters to discuss the study’s findings. Meanwhile, “partisanship just isn’t for politics anymore,” he said, noting investors often “look to sources they think [are] going to back them up” and prove they’re right about their own opinions.

It wasn’t clear how much of a role political biases might impact investment decisions and Cerulli didn’t specifically ask advisors about them, he told ThinkAdvisor. But he said such biases are likely pretty much covered by the biases Cerulli did ask the advisors about.

Meanwhile, one reason it doesn’t logically make a whole lot of sense to make investment decisions based on events that just happened is that, these days, “every day we seem to have a new normal,” such as low interest rates currently, according to Omar Aguilar, chief investment officer of Equities and Multi-Asset Strategies at CSIM.

A “perfect example” is Brexit, he told reporters, noting that many investors at the time U.K. citizens voted to leave the European Union were concerned about the ability to do any future business with the U.K. or Europe overall and the stock market fell more than 5%. But it’s about “three years later and we still don’t have Brexit,” he said.

Amid the current market volatility, it’s especially important now for advisors to understand the psychological or emotional factors that predispose investors to behavioral biases, so they can better differentiate their services, according to Aguilar. “The fact that we have these major shifts in the markets basically make these biases even more prevalent,” he told reporters, adding the “reason why we care about behavioral finance is because the human brain doesn’t work well under stress.”

The best approach investors can take to counter unconscious biases when making investment decisions is to take a long-term view, according to 62% of advisors surveyed. Advisors also singled out implementing a systematic investment process (52%) and integrating goals-based planning (47%) as very effective techniques for mitigating the potential risks that an individual’s unique emotional or cognitive biases may pose to their long-term financial goals.

Also significant was that 71% of advisors surveyed said they incorporated behavioral finance principles into their client communications and interactions, while only 58% said they applied the concepts to portfolio construction, according to the companies. The survey results indicated advisors are aware of the benefits of incorporating behavioral finance principles into their practices. Forty-six percent of surveyed advisors indicated that incorporating behavioral finance enabled them to better manage client expectations, while 40% said that gave them the ability to reduce their clients’ short-term emotional decisions. Meanwhile, 30% of surveyed advisors said incorporating behavioral finance helped keep clients invested during periods of volatility. But many advisors also said they lacked the resources and tools to bridge the gap between the concept and practical application. Sixty-five percent said the main reason they didn’t integrate behavioral finance into their practice was because they had difficulty translating behavioral theory into implementation, while 54% cited a lack of software or tools.

Advisors, meanwhile, must be mindful of their own biases when making investment decisions, according to the study. Twenty-nine percent of advisors cited loss aversion as their most significant bias, followed by overconfidence bias — overestimating one’s own abilities — at 17% and confirmation bias at 9%. While advisors might recognize and be aware of such biases, “there is more that can be done to manage their own internal behaviors to help improve investment outcomes for their clients,” a white paper on the study’s findings said.

“Recognizing behavioral biases is an important first step to keep emotions in check and avoid missteps that may have a negative impact on long-term financial goals,” according to Asher Cheses, research analyst, high-net-worth at Cerulli. “Advisors who incorporate behavioral finance principles into their practice can help their clients put guardrails in place to avoid irrational decision-making and better adhere to a long-term financial plan,” he said in a statement.

The survey revealed advisors and their clients “can benefit from more behavioral finance education, training, support and tools, which is why the Investments & Wealth Institute has focused on providing that educational knowledge base through our certifications, on-demand courses and conferences,” including its Behavioral Advisor Forum, being held in San Francisco this week, according to Sean Walters, its CEO.

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