In the last post, we looked at what behavioural finance is and how it affects us. Here, we discover some more of the biases we can all fall prey to.
Loss and regret aversion – this is self-explanatory. We all try to avoid pain and loss wherever possible, but sometimes we take this step further and hope to avoid the regret which comes from loss. Is isn't that the loss so much as the feeling of regret about it that we seek to avoid.
Hindsight bias – here we convince ourselves believe that a past event was in fact both predictable and avoidable when in truth it was nothing of the sort. We can then try to apply that perceived predictability to future events, especially where circumstances appear to be similar to the previous event. It’s completely nonsensical, but understandable.
Familiarity bias – I most often see familiarity bias at play when clients hold shares in the company that they work for. Because they know the company, and to some degree the management team, they hold and even buy more of the stock because they have confidence in the future of the company, which may be misplaced. They may not know what’s going on at all, and the fact that it’s familiar works against them.
This bias can also manifest itself in our asset allocation. Too often we have far too big an allocation to our home market, again because it’s familiar. Actually, there is a world of value outside the UK.
Self-attribution bias – put simply, this is where we take credit for events going in our favour when in fact we had nothing to do with it. The fact that we chose to buy and hold a share which tripled in value was nothing more than good luck, no matter what we think.
Worry – we all worry to some degree. When we worry, our brains project forward possible future scenarios, almost always negative ones. We then apply the emotions is linked to these scenarios to our present-day decisions, which rarely makes for a good outcome.
See what I mean? And that is probably a tenth of the biases and behaviours that the field of Behavioural Finance is concerned with. The first step to overcoming these is being aware that they’re there.