TRANSCRIPT:
It’s Alex Wolfe at Base Wealth Management. Emotions play a significant role in our financial choices. Investors tend to invest with feelings and reactions instead of rational and data-backed principles. Today, we are going to dive into behavioral finance and the study of how our human psychology influences our financial decisions. Hi, I’m Alex W., Certified Financial Planner and Head of Financial Planning at Base Wealth Management. Behavioral finance is a great topic that many investors fight with on a daily basis. Let’s get into some of the common behaviors and biases that we often experience.
First is confirmation bias. This is when investors have a bias towards accepting information that confirms their already held belief in an investment. You search or seek out information to confirm you are correct in your decision, even if the information is flawed. One of my personal favorites is recency bias. This occurs when someone’s memory of a recent event leads them to believe that it is far more likely to occur again. For example, the financial crisis of 2008 and 2009. Many investors exited the stock market, and many did so at or near the bottom, locking in massive losses. Many of these investors were fearful of getting back into the market as they expected more economic hardship in the coming years. This negative event created a bias or likelihood that another market correction would happen again when, in reality, the markets bounced back, and historically speaking, the largest market returns happened just following a market correction.
Next, we have loss aversion. This occurs when an investor places a greater weighting on the concern for losses than the pleasure from market gains. Let me clarify this meaning in more simple terms: They are far more likely to have a higher priority to avoid market losses than making investment gains. As a result, they typically want a higher payout to compensate for the losses. If the high payout is not likely, they may try to avoid losses altogether, even if the investment’s risk is acceptable from a risk-reward standpoint. I find many coins fall into this bias, and let me tell you what I mean: Some investors are very hesitant to sell a stock at a loss and end up hanging on to their losers because they have a bias in thinking it will come back, and they want to break even. What they are losing out on is selling that stock and investing in something else that may return a better result.
Lastly, we have familiarity bias. This is where an investor tends to invest in companies or sectors they know and are familiar with. What happens is they do not end up diversifying and are going to be concentrated in that familiar sector that they are comfortable with. They often think they are reducing risk but end up with more risk due to a lack of diversification.
What does all this mean or help with, anyway? The study of behavioral finance and uncovering our natural biases help us make better financial decisions and act with more rational emotions. Investors that understand and avoid these biases have a better chance of creating a stronger portfolio and achieving better returns. For many, this means letting a professional handle their investing, and even better is having a financial plan to guide your investment portfolio for optimal results.
Thanks for watching this video on behavioral finance. If you found this helpful and want to see more content, please subscribe to our channel and be sure to check out our website, Baswealthmanagement.com. I’m Alex Wolf, Certified Financial Planner. We’ll see you next time.
