The study of financial behavior is a fascinating aspect of the savings and investment world and one about which many erudite tomes have been written. In essence, this combines psychology with economics to try to understand why people make certain, often irrational, financial choices.
There are a number of commonly used examples of the way people tend to act – termed behavioural biases – and we can all probably relate to at least one of them when we view our past actions. Here are a few:
- Present Bias – giving increased bias to payoffs that are closer to the present time (e.g. short term over long term investment returns);
- Anchoring – relying too heavily on the first piece of information we are offered (the anchor) when making decisions;
- Framing – decisions influenced by how a choice is presented, e.g. as a potential gain or a loss;
- Over confidence – when our subjective confidence in our judgement is greater than the objective accuracy of them;
- Herd bias – rationalising a decision through its adoption by ‘everyone else’;
- Loss aversion – our preference for avoiding losses over acquiring gains.
To illustrate these let’s take the example of the technology boom and bust that occurred on the stockmarkets in the late 1990s. On the back of the rise in use of the World Wide Web (as it was termed then) and the opportunities this was deemed to present, all things Internet seemed to be able to do no wrong, pushing up the stockmarkets to unprecedented highs.
This saw investors (and hitherto non-investors) jumping on the ‘tech’ bandwagon – sometimes as their only investment strategy.
Investors saw the potential to make, what they believed would be quick money (Present bias); the good news story was all over the media (Anchoring); people were talking about and talking up how much could be made (Framing); everyone seemed to be buying in (Herd bias); so it seemed an opportunity not to be missed (Over confidence).
The problem was that many people bought into the market when the dotcom boom was at or nearing its peak. As we know, the bubble then burst and the stockmarkets fell dramatically. Rather than take a long-term view, that the market would stop falling and correct itself in the longer run, investors panicked and piled out of their tech investments (Loss aversion) and in doing so, ironically, cemented in their losses.
People were harmed financially by the dotcom boom not just because they lost money but because it put them off investing, in some cases for many years, which meant they failed to benefit when the stockmarket recovered.
As Independent Financial Advisers we see an important part of what we do as helping people not to make those irrational choices which will harm their finances. This is why we have developed, over many years, tried and tested means to invest with a long-term outlook. We aren’t influenced by market volatility, the latest trend, media stories or the behaviour of other investors. We have people dedicated to keeping our portfolios well managed, diversified and built not to chase short-term gains but to benefit from market rises and mitigate against market falls, with the long term in mind.
Our role is to counter the irrational forces in the market with well thought out investment strategies and so help grow and protect our clients’ wealth.
Regardless of your stage in life, the actions you take now could dramatically improve your financial wellbeing for years to come so there is never a bad time for you to benefit from obtaining appropriate financial advice Lowes.