Investing is a highly emotional endeavor given it relates to our future wellbeing. The question is, can you recognize when your biases are negatively impacting your investment judgement?
In this episode of Conversations on Wealth, Sarah Widmeyer speaks with Chief Investment Officer Craig Basinger to learn about some common investment biases, what to be aware of when investing and, most importantly, what kinds of decision-making processes to avoid as an investor.
Sarah Widmeyer 0:16
Welcome to Conversations on wealth hosted by Richardson GMP. A podcast dedicated to helping Canadians navigate the complexities of wealth with a multi-dimensional approach to planning and wealth management. I’m Sarah Widmeyer, Director of Wealth Strategies at Richardson GMP, and this week we’re discussing behavioral finance.
Joining me today is our in-house expert on the subject Craig Basinger, Chief Investment Officer at Richardson GMP. Craig, thanks so much for joining me this afternoon.
Craig Basinger 0:50
Well, thanks for having me. I’m a longtime listener of a whole bunch of different podcasts so this is a special treat to be on the other end of it.
Sarah Widmeyer 0:57
Awesome! So I’m going to start with a really basic question: Craig what do you do?
Craig Basinger 1:07
We do a number of different things but on this topic of behavioral finance we really started going down this path a number of years ago. Full disclosure I accidentally have an education in both economics and psychology, and behavioral finance is the combination of those two disciplines putting them together. Now I did not have any foresight into that that was actually more of a mistake. I just wanted to go back to school for another year. But it actually worked out exceptionally
Behavioral finance is really it’s a combination of psychology and economics but it’s really the study of how we make decisions. We make decisions in a whole bunch of different ways and we have certain experiences in our lives that dictate how we perceive things and how we come to our conclusions and make decisions. Most people think we make you know lots of rational decisions and everybody sort of weighs the pros and cons, but the fact is that’s really not what happens. Very often we rely on shortcuts in our minds and that can cause us to make some mistakes.
Sarah Widmeyer 2:10
That’s really cool. So how is it then applicable to investing? I can already start to think about how you know selling at the wrong time buying at the wrong time. Tell me a little bit more about that – how is behavioral finance or behavioral science really applicable to investing?
Craig Basinger 2:33
Yeah I mean the whole the whole discipline has some pretty broad reaching applications but within government policy in other areas but it seems to have really found a very strong following when it comes to investing.
I think the reason behind that is if we have all these shortcuts and biases that sort of help us get to our conclusions quicker than actually thinking about things too much, and those biases tend to rise up especially when we’re emotional. And like it or not investing is a pretty emotional practice. It’s your nest egg, it’s your future, it’s your your comfort in retirement that’s at risk here at either growing fast enough or even dare I say declining. So it’s a very emotional practice – investing – and and I think that causes a lot of these biases to rear there potentially ugly heads, and potentially mislead people into making bad choices.
Sarah Widmeyer 3:29
So can you give me an example of what a bias might be? When you refer to biases, what do you mean?
Craig Basinger 3:32
You know one of the most prevalent ones in society and this goes even beyond investing is actually confirmation bias. That’s where we search out information that supports our pre-existing views. If you watched any of the political debates recently then you would have probably resonated better when somebody was talking about something that you already believed in. And when somebody was saying the opposite you were immediately discrediting them or not putting any emphasis on what they’re saying. And this happens everywhere in life.
This happens when you search things on the internet. Google knows what your preferences are and they tend to feed you ads that feed your confirmation bias. They’re not trying to give you the objective level playing field. They’re trying to sell ads. So they know what you like and what you’re more likely to click on and they’ll feed that confirmation bias. But that’s in everyday life.
When it comes to investing, it can be negative as well because if you have a view on the markets, a company, a sector, you’re just more likely to read reports or opinions that support that view. When you come across contrary or views against you are pre-existing to views, you kind of ignore those. And this can really cause, from a portfolio management perspective, you to miss turning points, miss the other side of an argument. Your portfolio can become too concentrated. If it’s in one specific sector that you really love, love, love, you can then be taking on a lot of undue risk.
Sarah Widmeyer 5:06
Performance chasing is another common behavioral mistake right? Not knowing when to sell.
Craig Basinger 5:13
Sometimes, or knowing when not to hold. It can actually go both ways. unfortunately performance chasing is probably amalgamation of a number of different biases. So performance chasing on the upside like, let’s say, marijuana stocks. Not now, but maybe six months ago. But, you know, believing you’re missing out on something can cause people to say “hey, listen my neighbor’s making money by investing in this.” Or whether it’s technology or any other sector. And then that lures you off your pre-existing path that you’re on to achieve your long-term financial goals because you want to do what your neighbors doing. Or your right fear of missing out and that herd mentality then brings you over. And that’s one aspect of performance chasing. Our industry feeds it. There is no question that any asset management company is well aware of performance chasing. You cannot walk around any of the underground path during RSP season without seeing a giant mountain chart of a sign that’s crushed it for the last five years. And that’s trying to feed your “oh my god I’m missing out, I need to get into that fund now.”
But it can work the other way too because very often something stops working. An investment style stops working and it can start underperforming. It can underperform for a number of years even. And in many cases that’s actually very often the worst time to sell because it’s just out of favor for a number of years. Say it’s value versus growth, and it cycles, and it goes back and forth. And if you you know continually bail on what’s not working looking at the last couple years and try and chase what’s been working for the last couple years, you’re effectively going to chase your tail. And you’re invariably going to end up with a smaller nest egg when you’re done.
Sarah Widmeyer 6:56
Yeah, so it sounds like then behavioral finance is kind of protecting us from our worst selves. Or protecting us from performance chasing, or FOMO fear of missing out, or overconfidence. Or it’s protecting us from ourselves. Does that make sense?
Craig Basinger 7:22
Yeah a little bit. I will flat out say that even studying behavioral finance will not help you avoid all of these mistakes. It’s not the cure. But I but I will say depending on what the biases are, and depending on what sort of the mental shortcuts that people use, understanding what those biases does go a long way in helping you mitigate some of the potential risks. Even understanding confirmation by us, for our team on the asset management side, we understand it. If we have all of the same view on one aspect, we actually force ourselves to go read contrary reports. Or have a bull bear case where we task somebody with taking the other side of the argument to try improve the process. And that’s a lot of what we do on the investment side.
But I think understanding them helps. And what also helps is actually getting a second opinion. Even if you’re an investor – and full disclosure, Advisors have just as many biases as the individual investor – who doesn’t…
Sarah Widmeyer 8:27
Oh for sure, you can imagine how that would be. Yeah.
Craig Basinger 8:30
Absolutely. One of the neat things we’ve found with a lot of the survey work and interviews we’ve done with advisors and clients is very often they have different biases. So a client will be more likely to suffer the herd mentality, if they’re hearing more of their friends at a cocktail party or making money on a certain area.
Advisors will suffer from different biases. Sometimes over confidence in their abilities to outperform the market. We all have seen the stats that very few people do outperform the market over the long term. But what the second opinion does is they’ll have different biase and they’ll have different times. And when it’s your emotions that really cause your biases to rise up and potentially mislead you, that increases the probability of that happening. When you do get that second opinion they won’t have that same emotional level, they won’t have the same biases and you can potentially get to a better decision.
Sarah Widmeyer 9:23
Interesting, so are their unique biases that occur in volatile markets?
Craig Basinger 9:31
Yeah well, I mean, volatility brings out emotion and that brings out a whole bunch of different biases. But there’s probably two big ones that really resonate. And I’m going to assume when you say volatile you mean going down because that’s…
Sarah Widmeyer 9:44
I guess, yeah. Rising, no. But choppy.
Craig Basinger 9:48
Everybody loves upside volatility, but we just call that a good market. And then what’s going down we call it volatile. I’m not sure if that’s behavioral or not but, that could be more marketing. But availability bias is a big one.
So availability bias is the fact that we all live many, many years and there are certain events that have happened in our lifetimes that tend to be more vivid, and they are etched in our brains. And we can recall those much easier.
A prime example obviously is the financial crisis in 2008, early 2009. It was a very vivid event. it was very volatile. A lot of people lost money during that period. Although, albeit made it back after if they stayed invested. The fact is, it’s such a vivid event. It causes people even when markets are down five percent or something weird’s going on in the credit market, everybody jumps to the conclusion that it’s gonna be the same thing again because that’s such a vivid memory. Lost is the fact that that was a credit driven financial crisis and then one previous to that was in the 1930s. So you could layer some statistics on that. The chances are in 2019 or 2020, we’re probably not gonna have the same kind of event again. But it was such a vivid memory that it’s etched in people’s minds and they make decisions based on that etching.
And I’ll even go back to the you know the early 2000s. You couldn’t convince anybody to buy a company like Microsoft or Cisco because it was after the tech bust and people were like that’s etched in my mind. Technology equals bad. And that takes many many years to dissipate and to fall off. I think volatile markets cause that to come out quite a bit.
The other is recency. If the market goes down 5% this week, you know everybody’s getting all fired up and concerned about what’s going on. And you know the fact is the market has actually just gone back to where it was three weeks ago. But you’re only looking at what’s going on right now and you’re really over waiting today. And it’s driving you to – two of our evolutionary characteristics is we want to react and protect and that helped us. It helped us move from the savanna into civilization, and it helped us avoid lions, and that type of thing. But if you actually think about what reacting and protecting is, they are actually two of the behaviors that are terrible for investing because protecting wouldn’t variably lead you to say okay make me a little bit of money but I just don’t lose anything. so I’m gonna be ultra conservative even though your time horizons you know 20-30 years till retirement, and reacting obviously is well, reacting. And very often when it comes to investing not reacting is the thing to do. And both of those are very difficult from an emotional behavioral perspective for people to do.
Sarah Widmeyer 12:37
So what strategies then can investors use to help mitigate and counter the biases?
Craig Basinger 12:44
Yeah so we’ve actually come up with a number – we’ve created a checklist that people can find on our website that talks about what to ask yourself when you’re making an investment decision. But we also, on the back of it, developed a number of tools that can really help. I will say one thing that can help you avoid behavioral mistakes is: One, stop watching TV. And don’t get me wrong, TV’s great. Even financial news is informative. But it’s very often polarizing because, again, similar to Google and similar to Facebook, they’re trying to keep your eyeballs attached to that so if they can give you a polarized view, they know more people will watch and more people will pay attention. And that’s really what they’re trying to do because they’re selling ads and they need people to watch. So the media can be very misleading from that perspective
Think of your future self. Depending on your age, depending on how long you’re gonna be investing for, you know what your long-term plans are. You know one of the firms in the U.S. did this really neat thing with – it was U.S., 401k down there versus our RRSPs – but when young people would come on and open up an account they would take their picture and they would put it into a facial program that would age them twenty five years. And all of a sudden when you look at yourself 25 years from now (and depending on your age you might not want to do this) but you know when you look at yourself 25 years forward, all of a sudden you go “that person’s gonna need some money because they look like they’re gonna be retired at that point, so I’m actually going to be more serious about saving.” So thinking long term really helps.
If you’re feeling overwhelmed by the markets, simply taking a break. It’s very very rare in our industry that you need to make a decision today. Don’t ever feel pressured and if you’re unsure about it, sleep on it for a couple nights. That helps quite a bit as well.
And at the end of the day, education is key. Learning about behavioral finance. Learning about the benefits of long-term investing and staying the plan, developing a long-term financial plan and sticking with it can actually make you think longer term. And if you can continue to think longer term you can easily defeat a lot of the behavioral biases that exist out there.
Sarah Widmeyer 15:00
That’s great advice. So how can clients and investors then leverage their advisor when it comes to behavioral biases? How can they work better with their advisor?
Craig Basinger 15:14
I think it’s being open, honest and asking a lot of questions. It comes down to it even if and you know our industry is quite special – a lot of the relationships wit a client and advisor really change over time, and everybody’s relationship is somewhat different, so they’re all kind of customizable. But if you are unsure about things and you are uncertain and you are feeling emotional, talk to your advisor and tell them because it’s possible they don’t know or aren’t you know reading your subtle clues well enough. But really communicating and learning more of this space and the whole investment process goes a long way
Sarah Widmeyer 16:09
That’s great advice. I think I’m going to become a lot more self aware as to what my biases are. And, you know, what I found very resonating was that hole of flight or protect. And just being aware of those biases, as I’m thinking about investing and thinking about working with my own advisor, any other parting advice, or things that you think we should be thinking about?
Craig Basinger 16:35
It is kind of fun, but actually, if you try and lift yourself out of your everyday. We walk through life making decisions and like moving around and doing things. But if you could actually lift yourself a bit and look at the decisions you’ve made and analyze them from both sides, you know what were you thinking at the time, what were you not thinking at the time, what surprised you.
One of the things we do on the investment side is is we actually write down rationales on everything we do whenever we’re doing anything. And it’s very enlightening to then go back in time and read those and and say you know what this did. This was a bad decision, but reading my rationale at the time I still agree with it, which means it wasn’t a bad decision. it had a bad outcome. And trying to separate the outcome and the decision and the process I think is key for being a successful investor. And I think incorporating more of things that we can learn on behavioral finance can also help make you a better investor.
Sarah Widmeyer 17:30
Yeah, oh that’s awesome. Thank you so much for joining us today, Craig. I certainly learned a lot. And as I said, I’m going to take it forward as I think about how I’m investing and making some of the decisions that I am within my portfolio, of course with my advisor.
Craig I’d like to thank you once again for joining us to lend your thoughts and expertise on this topic.
If you’d like to learn more about behavioral finance to help you avoid some of the biases that may undermine your investing efforts, you can visit our website at RichardsonGMP.com for articles and videos on the topic. Remember to subscribe to Conversations on Wealth wherever you get your podcasts, and follow us on LinkedIn for a broad range of information on wealth strategies.
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