The ABCs of Behavioral Biases Series
“The investor’s chief problem – and even his worst enemy – is likely to be himself.” — Benjamin Graham (1894–1976)
Legendary economist and investor Benjamin Graham made his timeless observation decades ago, and yet it reflects our enduring belief: Your own behavioral biases are often the greatest threat to your financial well-being.
As investors, we leap before we look, stay when we should go, and cringe at the very risks that are expected to generate our greatest rewards. All the while, we rush into nearly every move, only to fret and regret it long after the deed is done.
Why Do We Have Behavioral Biases?
Most of the behavioral biases that influence your investment decisions come from the myriad mental shortcuts you depend on to think more efficiently and act more effectively in your busy life.
Usually (but not always!), these shortcuts work well for us. They can be powerful allies when we encounter physical threats that demand reflexive reaction or even when we’re simply trying to stay afloat in the rush of deliberations and decisions we face every day.
What Do They Do to Us?
As we’ll cover in this series, those same survival-driven instincts that can otherwise be so helpful can turn on us as investors. They overlap with one another, gang up on us, confuse us, and contribute to multiple levels of damage to us.
Friend or foe, behavioral biases are a formidable force. Even once you know they’re there, you’ll probably still experience them. It’s what your brain does with the chemically induced instincts that fire off in your head long before your higher functions kick in. They trick us into wallowing in what financial author and neurologist William J. Bernstein, MD, PhD, describes as a “Petrie dish of financially pathologic behavior,” including:
Counterproductive trading: We incur more trading expenses than are necessary, buying when prices are high and selling when they’re low.
Excessive risk-taking: We reject the “risk insurance” that global diversification provides, instead over-concentrating in recent winners and abandoning recent losers.
Favoring emotions over evidence: We disregard decades of evidence-based advice on investment best practices and instead let our “gut” be our primary guide.
What Can We Do About Them?
In this multipart “ABCs of Behavioral Biases” series, we’ll offer an alphabetic introduction to investors’ most damaging behavioral biases, so you can more readily recognize and defend against them the next time they’re happening to you.
Here are a few additional ways you can defend against the behaviorally biased enemy within:
Anchor your investing in a solid plan: By anchoring your trading activities in a carefully constructed plan (with predetermined asset allocations that reflect your personal goals and risk tolerances), you’ll stand a much better chance of overcoming the bias-driven distractions that rock your resolve along the way.
Increase your understanding: Don’t just take our word for it. Here is an entertaining and informative library on the fascinating relationship between your mind and your money:
· “Predictably Irrational,” Dan Ariely
· “Why Smart People Make Big Money Mistakes,” Gary Belsky, Thomas Gilovich
· “The Behavioral Investor,” Daniel Crosby
· “Stumbling on Happiness,” Daniel Gilbert
· “Thinking, Fast and Slow,” Daniel Kahneman
· “Noise,” Daniel Kahneman, Cass Sunstein, Olivier Sibony
· “The Undoing Project,” Michael Lewis
· “Nudge,” Richard Thaler, Cass Sunstein
· “Your Money & Your Brain,” Jason Zweig
Don’t go it alone – Just as you can’t see your face without the benefit of a mirror, your brain has a difficult time “seeing” its own biases. Having an objective advisor is among your strongest defenses against all of the biases we’ll present throughout the rest of this series. Look for an alliance that is well-versed in behavioral finance, dedicated to serving your highest financial interests, and unafraid to show you what you cannot see for yourself.
As you learn and explore, we hope you’ll discover that you may be unable to prevent your behavioral biases from attacking your financial resolve. But forewarned is forearmed. You stand a much better chance of thwarting them once you know they’re there!
In our next piece, we’ll begin our A–Z introduction to many of the most common behavioral biases.
If you want to discuss this or anything else that is on your mind, we offer a complimentary 15-minute call to discuss your concerns and share how we can help.
This information should not be construed as investment, tax, or legal advice. This commentary reflects the personal opinions, viewpoints, and analyses of the Stordahl Capital Management, Inc. employees providing such comments and should not be regarded as a description of advisory services provided by Stordahl Capital Management, Inc. or performance returns of any Stordahl Capital Management Inc. Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this piece constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Accessing websites through links directs you away from our website. Stordahl Capital Management is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve of or endorse the information provided. Users who gain access to third-party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from the use of those websites. Please note that trading instructions through email, fax, or voicemail will not be taken. Your identity and timely retrieval of instructions cannot be guaranteed. Stordahl Capital Management, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.