In today’s blog: a poodle named Scarlett, offended by my investment advice, teaches us an important lesson about the biases that can hinder our financial success.
A couple of weeks ago in our blog looking back over 2023, I compared the different sectors of the stock market to the many different breeds of dogs. In our 2024 Market Outlook I offhandedly made the statement that you should not “buy too many poodles”.
I didn’t even realize that my dogs paid attention to my blog, but my son informed me that I had offended my poodle, Scarlett! I’m not one to shrug off an offense so I explained to her that while I think she is one of the best dogs in the world, I can’t let my bias towards her influence me to buy a bunch more poodles.
It’s a delicate subject, but I gently reminded Scarlett that she’s seen the consequences of this kind of bias. She herself was a rescue pooch from a home where her former owner lived by the mantra “More Poodles!”
I think she got the point.
The Influence of Cognitive Biases
On my way to work this morning I was pondering how often I’ve seen the consequences of biases in decision making. Usually, our personal biases are based on facts, so we feel confident in them. But while biases are BASED on facts, they inspire feelings that cause us to ignore other facts and skew our decisions.
We’ve all seen the girl in love who ignores warning signs in a relationship, or the overconfident driver of a 4×4 pickup who flies by other drivers on dangerous winter roads.
Biases affect just about every area of our lives and investing is no exception. It’s easy to identify the folly of biases in other people, but it can be difficult to identify them in our own lives.
Common Biases
Confirmation Bias:
My dog Scarlett is very well trained. I could take her on long walks without a leash and she’d never walk ahead of me. Except for occasionally shredding an entire roll of toilet paper, she is not a destructive dog. My grandma had a poodle named Muffin who was much the same way. I have a friend who raises poodles, and they are the SWEETEST little pups.
My nephew, on the other hand, has two poodles who are the most hyper dogs you’ve ever met. They have destroyed furniture and even drywall. Because of my confirmation bias, I tend to believe that these dogs are simply poorly trained and not a reflection on their breed.
Confirmation bias is often applied in investing as well. We all tend to seek out information that confirms our beliefs while disregarding things that challenge them.
The internet is no help. In fact, search engines are actually programmed to reinforce people’s confirmation bias. Based on our previous search history, the internet “learns” to feed us the kind of information that we’re looking for.
This confirmation bias can lead investors toward a lack of diversification. This may, for instance, prevent an investor from making necessary adjustments in their portfolio.
Anchoring and Recency Bias:
Anchoring bias happens when we accidentally rely too heavily on the first or most recent piece of information we encounter when we’re evaluating our options. This initial information acts as an “anchor” and influences our subsequent decisions.
Salesmen are acutely aware of our tendency toward this bias. The first price they quote you is their “anchor”. Once they’ve established this anchor, every dollar they take off and every extra upgrade they “throw in” makes you feel better about the deal. Your mind is still working off the anchor price.
Anchoring and recency bias is very common amongst investors. How we feel about our investment portfolio is anchored to the value of our current statement compared to the value of another recent statement. When our statement shows that we are up compared to last year, we feel good about that. When our statement shows a decline, even if we’ve had a great long-term average in our portfolio, we tend to feel melancholy. Our minds are anchored to a more recent higher value.
These two biases are just a small sampling of the many many biases we face in life and in investing. From selective information gathering to overconfidence in beliefs, our biases hinder us from making sound decisions.
It’s important to recognize and actively challenge the biases that influence us so that we can find better objectivity.
But it’s so hard! It’s so hard to see our own biases because we’re… well… biased!
Don’t ask yourself “Do I have any biases that affect my financial decisions?” We ALL have biases. Instead ask yourself, “WHAT are my financial biases?” And “HOW are they impacting my financial decisions?”
When it comes to investment biases, a financial advisor is so important. Just like Scarlett, we all need help identifying our biases. A financial advisor that is experienced AND speaks in ways that are easy to understand, can help you identify and neutralize your biases. Your advisor can provide you with some fresh perspectives and offer some different insights that may help you make better financial decisions. Being open with your advisor about your life’s “money story” can help you both unveil your biases and identify where those biases started to form. If you’re uncomfortable sharing those personal details with your advisor, maybe it’s time to find a new one.
Disclosures:
Investing involves risk. As a general rule you should only trade in financial products that you are familiar with and understand the risks associated with them. Impact Wealth Management LLC is a fee-only Registered Investment Advisor (RIA). We are based in beautiful Sioux Falls, SD and regulated by the State of South Dakota. Throughout this site, we went out of our way to present unbiased data believed to be from reliable and respected sources. However, its accuracy, completeness, and relevance are not guaranteed, and no responsibility is assumed for errors or omissions.