Beware of your behavioural biases in investing

Whether we are aware of them or not, we all exhibit behavioural biases. A bias is a systematic deviation from rationality such as always steering clear of certain car brands in traffic because you believe they attract bad drivers.

In many cases the impact of behavioural biases can be minor. But some can be damaging. Nowhere is that truer than with your investments, especially at  times of high economic volatility such as those in global markets recently. During those times it can be easy to slip from a rational investment path on to one based more on emotion.

Investors may be tempted to buy when markets are strong as they gain greater emotional reassurance from this. Likewise, they may seek psychological shelter by selling near market lows. While comforting in the short term, these knee-jerk reactions could lead investors to miss out on the benefits of remaining in markets over the longer term.

In our work to understand the psychology of investing we have identified four common biases. These affect any investor, but they can be especially elevated for those geographically removed from their investments; for example, those based in SA, Kenya or Nigeria, thousands of kilometres away from their money. 

The first step in overcoming those biases and getting the most out of your investing is knowing and understanding what they are. With that in mind, here are some of the most common behavioural biases that have a negative impact on investments. 

• Familiarity bias. While there’s a lot to be said for focusing on assets and asset classes that you know and are familiar with, it can be detrimental if you’re overly reliant on this approach. For one, it means you might miss out on returns from high-performing assets. It might also mean you take too long to move away from a failing investment just because of your historic attachment to it. 

Familiarity bias extends to other markets and geographies too. Just because you know and understand SA, for example, doesn’t mean you should exclude other markets, especially if they have demonstrable growth and opportunities.  

Avoiding local in-country bias is key not only when choosing your investments but also your advisers. There are many local advisers in any given country who may be competent in their local field, but lack a global view.

One of the most powerful ways of overcoming familiarity bias is with research. After all, one of the underlying causes of familiarity bias is fear of the unknown. And once you get to grips with a market or asset class, you’re a lot less likely to fear it. 

This level of research should also extend to the types of institutions and advisers working with your money. Uncertainty and volatility also present opportunities and in every sector there are “winners” and “losers” — being with an institution that has the knowledge to guide clients has a material impact not just to your bottom line but also your peace of mind. 

• Confirmation bias. A behavioural bias that many people are familiar with, confirmation bias is defined as the tendency to seek out, recall, and favour information that confirms your beliefs and values. 

Overcoming confirmation bias means seeking out views that are different to your own and taking a critical view of your sentiment towards markets, as well as that of the market itself.  Diversification of thought and perspectives is critical to creating and holding a balanced diversified investment portfolio. 

Private banking is a relationship built on trust and a quality banker will not just help you make the “right” decisions but also guide you to avoid the “wrong” ones. Having a trusted financial sounding board not only helps avoid confirmation bias but can also help you keep a cool head when it comes to market volatility and navigating through tough and uncertain times.

• Hindsight bias. How often have you turned to a friend after your favourite soccer, rugby, or cricket team has lost a big match and dissected all the apparently “obvious” things they did wrong? You might even say something like, “didn’t I tell you that our offside trap was a major weakness?“. That’s hindsight bias. You might well have said that, but you’re probably forgetting all the things you got wrong in the run-up to the performance too.       

From an investment perspective, hindsight bias can make investors regret not positioning their portfolio in a particular way ahead of a big market event. This can cause them to make more biased or emotional decisions in the future as a result. But timing the market is incredibly difficult and history shows the fundamental importance of time in the market for protecting and growing wealth over the long term. 

• Mental accounting. Many of us tend to mentally segment our money into different pools according to its intended use, which helps us better manage it. One downside to this approach however is treating it differently due to that intended use. You might, for instance, put increased value on money intended to get your children on the property ladder or that you’ve inherited from a deceased relative, and perhaps be too cautious with how you manage it. 

Though there’s value in allocating pockets of money to specific purposes, doing so shouldn’t come at the expense of getting the best possible returns for each allocation. Money is interchangeable and treating different pots of it differently because of emotional attachments isn’t helpful. Investors should always be thinking holistically about their wealth.

• Prabhu is SA CEO and African market head at Barclays, and Joshi head of behavioural finance at Barclays Private Bank