“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. We stay when we should go. We 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 them long after the deed is done.
For the next few weeks, Wisdom Wealth Strategies will look at behavioral biases and how they can affect your financial future. You’ll learn why some behaviors that you might not even be aware of can possibly derail your financial plan. By becoming more aware of how you think, it could change how you act. Let’s get started.
Why Do We Have Behavioral Biases?
Most of the behavioral biases that influence your investment decisions come from myriad mental shortcuts we depend on to think more efficiently and act more effectively in our busy lives.
Usually (but not always!) these short-cuts 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 rushing roar 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 are otherwise so helpful can turn deadly in investing. They overlap with one another, gang up on us, confuse us and contribute to multiple levels of damage done.
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 – incurring more trading expenses than are necessary, buying when prices are high and selling when they’re low.
- Excessive risk-taking – rejecting the “risk insurance” that global diversification provides, instead over-concentrating in recent winners and abandoning recent losers.
- Favoring emotions over evidence – disregarding decades of evidence-based advice on investment best practices.
What Can We Do About Them?
Here are a few 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
- “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 – well-versed in behavioral finance, dedicated to serving your highest financial interests, and unafraid to show you what you cannot see for yourself – is among your strongest defenses against all of the biases we’ll present throughout the rest of this series.
As you learn and explore, we hope you’ll discover: You may be unable to prevent your behavioral biases from staging attacks on your financial resolve. Next week, Wisdom Wealth Strategies will take a look at the four self-inflicted biases that knock a number of investors off-course. Could one of these apply to you?
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.