10 investor behavioural biases to look out for

  • Describe what behavioural finance is
  • Explain some of the biases that creep into investor behaviour
  • Identify some of the dangers that come with behavioural biases
10 investor behavioural biases to look out for

While business continuity plans may well have provided for a pandemic, who truly could have predicted the present Covid-19 pandemic and the effect it has had, including that on global investment markets?

It seems that, even on a daily basis, the gurus, pundits and observers are revising their opinions about its catastrophic effect.

It is as bad as the 2008 collapse; no, worse than that - the 1929 Wall Street crash - no worse still: the great plague.

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The whole world economy has shrunk; we are in the worst crisis for generations; some say it may never fully recover in our lifetime.

So how are advisers and investors coping? It is said that the Chinese symbol for crisis has two symbols: the one meaning danger and the other opportunity.

We all know that money can be made in a crash and crisis as well as lost. Which symbol carries more weight for you?

The current situation for most investors is probably a mixed bag; though on average things may look pretty bleak. So how are people coping?

Fight, Freeze and Flee.

According to the gurus, faced with danger there are three responses: fight, freeze and flee. But how does this translate into investor reactions to the current crisis?

There seem three equivalent responses: Worry, Ignore and Engage.

The worrier often seems paralysed by doubt and anxiety. Although they seem obsessed with their investments, they are unable to know what to do.

They may “trouble” their adviser in many senses wanting more reassurance than guidance. Some may be on an emotional roller-coaster, but whether high or low, they seem unable to make cool, rational decisions. It is the heart ruling the head.

We know that emotion is the enemy of rationality. A little bit of worry can do one good in the sense that it galvanises action: but too much can lead to panic.

Probably risk averse in the first place, worriers may become even more so in these uncertain times.

Some ignore the issue, choosing to disengage and flee. It is a very primitive response associated with repression and is a sort of phobia.

Thinking about their investments at the current time floods them with dread so they “don’t go there”, possibly until a time they feel more confident.

They do not contact their adviser and do not want to know until “the mist clears” and they feel able to address the issue.

Others will engage, indeed they are energised by the volatility. Some are glued to daily reports about shares “dropping to the lowest point”; “bouncing back” or “totally collapsing”.

They can be captivated by unprecedented volatility and may “hound” their adviser for advice.

Engagers are unlikely to be risk-averse but maybe prone to rapid “chopping and changing” of their portfolios. Some might inundate their advisers with questions of all sorts.

Bias and Behavioural Finance

The basic assumption of the Behavioural Finance experts is that we are not as rational as we think we are. Two psychologists (Kahneman and Thayler) have twice won the Nobel Prize for Economics by demonstrating that everybody (yes, advisers and investors alike) are prone to “short-cut”, “quick vs slow” and, therefore, biased decision making.