8 Common Investor Biases That Impact Investment Decisions

This article was originally published on investopedia.com

One of the biggest challenges to our own success can be our own instinctive behavioral biases. In previously discussing behavioral finance, we focused on four common personality types of investors.

Now let’s focus on the common behavioral biases that affect our investment decisions.

The concept of behavioral finance helps us recognize our natural biases that lead us to making illogical and often irrational decisions when it comes to investments and finances. A prime example of this is the concept of prospect theory, which is the idea that as humans, our emotional response to perceived losses is different than to that of perceived gains. According to prospect theory, losses for an investor feel twice as painful as gains feel good. Some investors worry more about the marginal percentage change in their wealth than they do about the amount of their wealth. This thought process is backwards and can cause investors to fixate on the wrong issues.

The chart below is a great example of this emotional rollercoaster and how it impacts our investment decisions.

 

The Psychology of Investing Biases

Behavioral biases hit us all as investors and can vary depending upon our investor personality type. These biases can be cognitive, illustrated by a tendency to think and act in a certain way or follow a rule of thumb. Biases can also be emotional: a tendency to take action based on feeling rather than fact.

Pulled from a study by H. Kent Baker and Victor Ricciardi that looks at how biases impact investor behavior, here are eight biases that can affect investment decisions:

  • Anchoring or Confirmation Bias: First impressions can be hard to shake because we tend to selectively filter, paying more attention to information that supports our opinions while ignoring the rest. Likewise, we often resort to preconceived opinions when encountering something — or someone — new. An investor whose thinking is subject to confirmation bias would be more likely to look for information that supports his or her original idea about an investment rather than seek out information that contradicts it.
  • Regret Aversion Bias: Also known as loss aversion, regret aversion describes wanting to avoid the feeling of regret experienced after making a choice with a negative outcome. Investors who are influenced by anticipated regret take less risk because it lessens the potential for poor outcomes. Regret aversion can explain an investor’s reluctance to sell losing investments to avoid confronting the fact that they have made poor decisions.
  • Disposition Effect Bias: This refers to a tendency to label investments as winners or losers. Disposition effect bias can lead an investor to hang onto an investment that no longer has any upside or sell a winning investment too early to make up for previous losses. This is harmful because it can increase capital gains taxes and can reduce returns even before taxes.
  • Hindsight Bias: Another common perception bias is hindsight bias, which leads an investor to believe after the fact that the onset of a past event was predictable and completely obvious whereas, in fact, the event could not have been reasonably predicted.
  • Familiarity Bias: This occurs when investors have a preference for familiar or well-known investments despite the seemingly obvious gains from diversification. The investor may feel anxiety when diversifying investments between well known domestic securities and lesser known international securities, as well as between both familiar and unfamiliar stocks and bonds that are outside of his or her comfort zone. This can lead to suboptimal portfolios with a greater a risk of losses.
  • Self-attribution Bias: Investors who suffer from self-attribution bias tend to attribute successful outcomes to their own actions and bad outcomes to external factors. They often exhibit this bias as a means of self-protection or self-enhancement. Investors affected by self-attribution bias may become overconfident.
  • Trend-chasing Bias: Investors often chase past performance in the mistaken belief that historical returns predict future investment performance. This tendency is complicated by the fact that some product issuers may increase advertising when past performance is high to attract new investors. Research demonstrates, however, that investors do not benefit because performance usually fails to persist in the future.
  • Worry: The act of worrying is a natural — and common — human emotion. Worry evokes memories and creates visions of possible future scenarios that alter an investor’s judgment about personal finances. Anxiety about an investment increases its perceived risk and lowers the level of risk tolerance. To avoid this bias, investors should match their level of risk tolerance with an appropriate asset allocation strategy.

Avoiding Behavioral Mistakes

By understanding the common behavioral mistakes investors make, a quality financial planner will aim to help clients take the emotion out of investing by creating a tactical, strategic investment plan customized to the individual. Some examples of strategies that help with this include:

  • Systematic Asset Allocation: We utilize investment strategies such as dollar cost averaging to create a systematic plan of attack that takes advantage of market fluctuations, even in a down market period.
  • Risk Mitigation: The starting point of any investment plan starts with understanding an individual’s risk tolerance.

The most important aspect of behavioral finance is peace of mind. By having a thorough understanding of your risk appetite, the purpose of each investment in your portfolio and the implementation plan of your strategy, it allows you to feel much more confident about your investment plan and be less likely to make common behavioral mistakes.

Working with a financial planner can help investors recognize and understand their own individual behavioral biases and predispositions, and thus be able to avoid making investment decisions based entirely on those biases.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Why Investors Can Be Their Own Worst Enemy

Investors often think they are doing better than they actually are. But the reality is that most investors are actually underperforming their benchmark. Two recent articles regarding behavioral finance — Which Investor Personality Best Describes You? and 8 Common Investor Biases That Impact Investment Decisions — detail a concept which is the thought that our own instinctive behaviors are the biggest challenge to us as investors. Another topic that we have written on is the issue with trying to “time” the market. What people often don’t realize is that these two concepts have more in common than you might think.

For over two decades, financial research firm Dalbar has been analyzing investor returns. It recently published its 22nd annual Quantitative Analysis of Investor Behavior study that compared these investor equity fund returns versus the market benchmark. The results showed significant underperformance from investors. Dalbar points out that “for the 30 years ended Dec. 31, 2015, the S&P 500 index produced an annual return of 10.35%, while the average equity mutual fund investor earned only 3.66%. The gap of 6.69 percentage points represents the diminished returns.”

So why is this the case?

As advisors, we have long preached the importance of cost and the large effects it can have on returns. While cost is a factor in investor underperformance, there are other factors that play even a larger role. The study showed that the biggest contributing factor to equity investors’ underperformance over the past 20 years is voluntary investor behavior. What does that mean? Let’s look at a couple of examples of investor behavior that contributes to underperformance.

1. Panic selling: The No. 1 rule in a market collapse is not to panic. Markets can be erratic with times of larger-than-normal volatility. Responding emotionally is never a good idea. Start by understanding what your risk tolerance is. At that point, make sure you understand your investments and what their purpose is in your portfolio. Finally, look at your portfolio as a whole and make sure it is aligned properly with your risk tolerance and goals.

2. Trend chasing/herd mentality/FOMO (Fear of Missing Out): As the phrase goes: what you see is what you believe. When investors see a stock continue to go up, or everyone around them is talking about buying that stock, it is easy to follow the crowd and jump in without thinking. History has shown us that past performance is no guarantee of future returns.

3. Overconfidence: Many investors feel they perform better than what is actually happening or real. This can cause investors to believe they can accurately time the markets.

Source: BlackRock; Informa Investment Solutions

Telling investors about these issues is one thing. Actually seeing the fixes put into practice is another challenge. The key point to remember is that we are often our own worst enemies when it comes to managing our own investments. Having a great financial and investment plan is irrelevant if you don’t have the mindset to follow through and stick to it. Becoming self-aware of these issues is a great first step.

This article was originally published on investopedia.com

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Shocked by the Market’s Drop? Chalk it Up to Recency Bias

Whether you realize it or not, chances are good that you are prone to something called Recency Bias, which is the common tendency to think that what has been happening recently will continue to happen in the near future.

If you, like many investors, are shocked and concerned about February’s sudden market volatility, it’s probably a result of Recency Bias. The last 18 months of smooth sailing without market volatility got many investors lulled into thinking that that trend would continue indefinitely.

We all know that markets experience volatility and, until 18 months ago, it was considered reasonably normal, but no one likes the thought of taking a loss. It’s hard not to panic if your oldest child is in college and her 529 just took a hit or if you’re a year away from retirement and your IRA just lost 15% of it’s paper value.

Although you no doubt know that impulsive trading is one of the least efficient ways to reach your true long-term investment potential, emotions are powerful drivers. In fact, in Robert Shiller’s book “Irrational Exuberance,” he states that the emotional state of investors “is no doubt one of the most important factors causing the bull market” we just recently experienced.

The chart below shows that investor sentiment dropped 30% in the beginning of the year, suggesting that investors’ overall attitude may have been veering from bullish to bearish, although it did bounce back this week.  What it also suggests is that Recency Bias caused investors’ to react more strongly to typical market volatility because it was a-typical during the long period of calm we just experienced.

The key in times of volatility is to keep your eye on your long-term goals rather than reacting impulsively to temporary trends. In Taking The Sting Out Of Investment Loss, Brian Boch advises: “The golden rule is to differentiate between [decisions] based on rational and prudent trading strategies on the one hand and emotionally-based, panicky decisions on the other. The former generally leads to success over time, while the latter tends to lead to failure.”

Here at Sherman Wealth Management we believe there is productivity and security in planning for the unknown by defining what it is you already do know. Knowing yourself, your emotions, and the risk you are willing to take is the first step. The second is creating a long-term financial plan with a conflict-free, Fiduciary advisor.

In a recent post, Ben Carlson wrote:

“The prep time for a market correction or crash comes well before it actually happens by:

  • Setting realistic expectations.
  • Mapping out a course of attack for when losses occur.
  • Making decisions ahead of time about what moves (if any) to make and when depending on what happens.
  • Deciding on the correct level of risk to be taken.
  • Building behaviorally-aware portfolios.”

The best solution to financial and emotional volatility is to work with a financial planner on a plan that will make you feel comfortable through the market’s natural ups and downs. You may not be able to control outside factors but you can control your reactions by recognizing how bias works and by preparing both emotionally and financially to reach the long-term goals that matter to you.

And, as always, if you’d like to review your plan and how your allocations conform to your own risk tolerance and response to volatility, please let me know and we’ll schedule a call.

I’m New Here

Our summer intern turned part-time associate Dan McKenna wrote a great piece about his experience being new to the biz that I thought was worth sharing.

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I’m new here.  

The best word I can think of for explaining the experience of being a freshly-graduated analyst entering this market is… baffling.  Every week I read the news that markets are hitting new all time highs, that we have shaken off the effects of the global financial crisis and that excellent Q2 earnings reports are the catalyst that will push stocks higher.  There is almost a weekly reminder that markets do not die from old age.  Yesterday, the Dow climbed back above 22000 as investor fears retreated.

On the other hand, every week I also read articles from investors screaming that the end is near, markets cannot possibly keep up with their current pace, P/E ratios are outlandish and we need to be paring back risk.  For example, a month ago, the co-founder and chief executive officer of DoubleLine Capital LP, Jeffrey Gundlach, said that risky assets are overvalued and that investors should be “moving toward the exits.”  Since then, markets have pushed even higher.

No wonder the average client is looking to their advisor with a look of complete confusion and truthfully, a fair amount of fear.  In times like these, the words of my graduate-school mentor (one of the most brilliant finance professionals I know) often ring in my ears.  He always reminded me of a piece of wisdom I want to share with you:

Nobody knows anything in this field.

By that he means… nobody knows for certain what is going to happen.  If we truly did know the future, we’d never have to work again.  We could all leverage up, pick the winners, and make so much money our eyes would glaze over.  But we don’t know the future.  That’s why we spend so much time crafting diversified portfolios and picking the right amount of risk for each individual’s unique tolerance.  Face it: you’re probably not going to achieve your daydream of being the protagonist of The Big Short who calls the financial crisis before it happens.

We have to understand that the difference of opinion is what makes a market exist.  Don’t forget that there is an incremental seller for each and every buyer in the market.  Right when you’re convinced to buy a security, someone else is convinced to sell.  That is just how it works.  

The simplest thing to do is to remain calm and stick to your plan.  At Sherman Wealth Management, we use broad-based financial planning that is designed around your unique risk tolerance and your goals.  Unless it directly affects your financial plan, ignore the noise in the markets and that nagging voice in the back of your mind that screams sell every time you read a negative piece of news.  

I might be new here, but I can predict the future just as well as the next guy.  

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

Why Utilize a Financial Advisor?

Sherman Wealth Management | Fee Only Fiduciary

Personal finance.  Don’t underestimate the adjective.

In today’s world, the rise of “robo advisors” have led some to (incorrectly) conclude that managing investment portfolios is simple.  As far as they are concerned, as long as you have a software program, you’re set.  Within minutes, a computer system can analyze your risk tolerance, determine the best investments for your unique situation and be setup to adjust it every three months if it falls out of line.  These programs provide low cost access to data-driven algorithms for trading.  We’ve discussed some of the pros and cons in our recent blog post.

But there is something missing if that is where the finance conversation stopped.

A glance at the Behavior Gap chart below points out the simple but incredibly valuable missing link: your lifetime returns are driven much more substantially by your own behavior than by the portfolio you have set up.  This is where the financial advisor steps in, because managing you and crafting plans around your individual needs, behaviors, and ideas is something a computer program cannot do.

There are entire books written about the human psychology of investing and how, if left unchecked, it can negatively impact returns.  In fact, the field of behavioral finance seeks to identify common biases that humans make when investing, including but not limited to: herd mentality, loss aversion, confirmation bias, availability bias, the disposition effect, familiarity bias and self attribution bias.  These are just some of the many important behavioral issues that the human connection you have with an advisor can help you avoid.

A computer program cannot tell you that you are overreacting to a report you read on the news, or explain that chasing returns is likely not going to provide a benefit.  A computer program can’t coach you through identifying personal goals or customize budgets that will grow and change as unexpected life events pop-up.  A computer program isn’t going to give you a call when they see a red-flag in your budget or spending habits.  A computer program can’t push you to think beyond a limited scope to identify all of your goals and priorities or be there to answer the phone when you have a question.  For example: Do you want to send your kids to private school?  Do you want to be there to support your parents as they age?

Don’t get us wrong: that hardly means you should shun technology.  At Sherman Wealth Management, we believe that a good financial advisor knows how to take the power that technology has to offer and add in all of the benefits that only a personal human connection can provide.  We believe that a good financial advisor is someone that you know and trust, who takes your financial plan as seriously as they would their own.  Here, we utilize a user-tech interface that allows our clients to manage all of the pieces of their financial plan, from cash flow to 401Ks, while allowing an experienced advisor to monitor it for new opportunities and to ensure clients are on the path to meet their goals.  That means you get access to all of their knowledge and expertise in combination with the power of technology to enhance returns, increase efficiency and provide you with flexibility and control.   As a fee-only fiduciary, we take that responsibility very seriously, and that includes taking advantage of all of the tools at our disposal.

Do you feel that you are getting what you need out of your advisory relationship?  If not, we encourage you to reach out to us at anytime here. Sherman Wealth Management’s approach is based on the understanding that personal finance should be just that… personal.

 

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

Is Financial Well Being the Key to Emotional Well Being?

financial well being

When you think of your financial advisor or financial plan, how do you feel? Gratified? Anxious? Indifferent? How much would you say your advisor has contributed to your sense of emotional and financial well being?

Most of us probably don’t ask ourselves those questions and yet, according to a 2016 Morningstar study, When More Is Less: Rethinking Financial Health, our sense of well being is an important element to consider when thinking about wealth management and financial planning.

A simple way to look at financial well being is that it’s the ability to:

  1. Fully meet your current and ongoing financial obligations
  2. Feel secure about your financial future
  3. Make choices that allow you to enjoy life

Seen that way, it’s clear how feeling secure financially can contribute to our overall emotional well being as well.

At the same time, not having a sense of overall emotional well being can have a negative, sabotaging effect on our financial well being, via decisions driven by anxiety, fear, insecurity, or some common behavioral biases.

Which comes first, emotional or financial well being?

The short answer is that either can.

While health, family, and friends are the most important things in life, we all know that feeling anxious financially can affect our important relationships. And we know that having a sense of financial well being can give us peace of mind that lets us more fully enjoy the life and relationships we have.

We also know that emotional well being – feeling emotionally secure and supported – can ground us so that we make better, more measured financial decisions. And that emotional distress can lead us to make reckless, impulsive, or biased decisions that can negatively affect achieving a secure and prosperous future.

What kinds of behaviors can derail financial well being?

Behavioral Science researchers have identified many simple yet critical attitudes and biases that can keep us from acting in our own best interest. Unconscious biases that can wreck havoc with financial well being include:

  1. The tendency for investors to react more strongly to negative news than to positive news
  2. Placing more weight – positive or negative – on current news than on the big picture
  3. A “herd mentality” that leads investors to follow the crowd, buying securities at their peak prices as a result

What’s the first step in achieving financial well being?

A good first step towards achieving financial well being is becoming aware of the role that our emotions and biases may be playing in our financial decisions, choices, and habits. Think about your financial choices and some of the last few big financial decisions you made: were there emotions involved, however subtly, that may have influence your choices? A good Financial Advisor, particularly one well versed in Behavioral Finance, can be enormously helpful. “By identifying specific patterns of thought that may sabotage a client’s overall financial health,’” writes Sarah Newcomb, Ph.D., a behavioral scientist for Morningstar, “an advisor can help guide clients into making better financial decisions and increase their satisfaction and peace of mind.”

An added benefit of identifying some of the emotions or biases that may be driving financial decisions: some of my clients have told me that discovering a bias that has affected their financial decisions has lead them to understand other ways that same bias has been affecting their life as well!

Nothing beats a sense of well being, and feeling more secure financially definitely contributes to a greater overall sense of well being and peace of mind. And emotional wellbeing – along with a good financial advisor – can keep you from sabotaging your own progress, and put you back in control and on your way to achieving your financial goals.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

Don’t Let Emotions Get in the Way of Your Investing Goals

discussing personal finance 1280×720 (1)

We all love to see quick results. Whether it’s career progress, a workout plan, or an investment portfolio, it’s exciting to see fast results. And it can be frustrating when progress doesn’t come quickly: when you’re not learning those guitar chords fast enough or your portfolio isn’t shooting ahead of the Dow.

Achieving real progress and real gains usually takes time in spite of tantalizing offers to get rock-solid abs in seven days, learn to flip houses in two weeks, or a discover sure-fire stock that’s the next Apple.

Wanting to See Quick Results

It’s human nature to crave quick results but when it comes to investing, your emotions – or a desire for quick gratification – can get in your way of building a solid financial plan. (For more about Behavioral Finance, see: 8 Common Biases That Impact Investment Decisions.)

In a recent article for The Motley Fool, columnist Morgan Housel made some excellent points about how we limit our chances of seeing real progress by letting our emotions get the best of us.

Frustration

“Most investing mistakes and frustrations come from trying to run a marathon in an hour,” Housel writes about the difference between short and long-term investing. “Companies earn profits, and over a long period of time those profits accrue to shareholders. If you leave it at that – and you should – investing is such a basic game that doesn’t require much action.” (For more, see Why Investors Can Be Their Own Worst Enemy.)

If we stuck to that game plan and utilized a long investment horizon to really take advantage of compound interest, the progress you would see would be impossible to ignore. Compound interest is a great way to look back and see the progress of your investments over a long time horizon. We summarize it like this:

Compound interest is often compared to a snowball. If a two-inch snowball starts rolling, it picks up more snow, enough to cover its tiny circumference. As it keeps rolling, its surface grows, so it picks up more snow with each revolution. If you invest $1,000 in a fund that pays 8% annual interest compounded yearly, in 10 years you’ll have $2,158.93, in 20 years that will be $4,660.96, in 30 years it will be $10,062.66, and in 40 years it will be $21,724.52. All it takes is patience to turn $1,000 – the price of one ski weekend – into $21,724.52. 

A main problem many investors have is they fail to allow for this long time-horizon to play out. Housel’s next point builds on this when he says…

Progress Happens Too Slowly to Notice

“Progress happens too slowly to notice; setbacks happen too quickly to ignore.” This ties into the idea of prospect theory and Housel summarizes this concept well: “Pain hurts more than the same level of gain feels good.” This is similar to the concept of loss aversion where investors make emotional decisions that unfortunately lead to doing the exact opposite that one should do. Take 2008, for example, when the markets lost almost 40% in a short period of time. Those who made emotional decisions and exited the markets quickly not only locked in a significant loss but likely missed out on one of the biggest bull markets in history as the market tripled over the next six years.

So much of this is human psychology. Having a dollar that stays a dollar doesn’t feel like you’re losing money. And losing a dollar often hurts more than gaining a dollar feels good. It’s like sports — losing a close game generally makes people feel lower than winning a close game makes you feel good. That’s what makes our job so interesting — working with people to park their psychology at the door, not just today, but forever. Not easy, but when done correctly you can really start seeing that elusive “progress” word come into play. (For more, see: Why Playing It Safe Could Hurt Your Retirement.)

Avoiding Catastrophic Mistakes

“Most investing success boils down to avoiding catastrophic mistakes.” You don’t need to be the world’s greatest stock picker to benefit from investing. Far from it actually. As Housel puts it: “Few good decisions are needed to do well over time.” Instead, what we need to do is avoid making the catastrophic mistakes that typically come from making an emotional decision and not planning properly. Market corrections happen. They will happen again. Without proper planning, it is easy to fall victim to the pitfalls of prospect theory and end up making an emotional, short-term decision that can derail any progress that you have made.

To summarize, all of this boils down to a simple line of thinking. When it comes to investing, leave your emotions at the door. If you are uncomfortable with your investments, that is something you should take immediate action in. You may be invested in a portfolio that is too risky based on your goals, risk tolerance and needs. You may just not fully understand how you are invested which makes you nervous. Worst of all, you may have no plan what so ever. Start by reevaluating your goals, short, mid and long term. Create a plan and road map to accomplish those goals, and then stick to it. (For more, see: Which Investor Personality Best Describes You?)

This article was originally published on Investopedia.com

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Which Investor Personality Best Describes You?

psycology-investment

This article was originally published on investopedia.com

According to many studies, our different personality traits and preferences, along with a range of emotional and mental behavioral biases, have a strong impact on the way we invest. This is commonly referred to as behavioral finance. As part of a two-part series on Behavioral Finance, we will start by exploring the different personality types of most investors. When it comes to money and investing, there are many factors that contribute to the “how” and “why” of important financial decisions.

Investor Personality Types

There are four different types of investors, according to the CFA Institute, each with their own distinct behavioral biases. Understanding your own investor personality type can go a long way toward helping you determine and meet your long term investment goals, as well as producing better returns. (For more from Brad Sherman, see: 6 Questions to Ask a Financial Advisor.)

Which of these profiles best describes you?

Preservers

Preservers are investors who place a great deal of emphasis on financial security and on preserving wealth rather than taking risks to grow wealth. Preservers watch closely over their assets and are anxious about losses and short-term performance. Preservers also have trouble taking action for fear of making the wrong investments decisions.

Common Issues with Preservers: An investment strategy should take into account short-, mid- and long-term goals. By overemphasizing short-term returns, an investor risks making an emotional decision based on the short-term performance, which may end up being more detrimental to them in the long run.

Accumulators

Accumulators are investors who are interested in accumulating wealth and are confident they can do so. Accumulators tend to want to steer the ship when it comes to making investment decisions. They are risk takers and typically believe that whatever path they choose is the correct one. Accumulators have frequently been successful in prior business endeavors and are confident that they will make successful investors as well.

Common issue with Accumulators: Overconfidence. We recently wrote a blog on the issue with stock picking and active management. Overconfidence is a natural human tendency. As investors, accumulators consistently overestimate their ability to predict future returns. History has shown that it is impossible to predict markets at large scale, yet accumulators continue to try and do so and expose themselves to extreme risk.

Followers

Followers are investors who tend to follow the lead of their friends and colleagues, a general investing fad, or the status quo, rather than having their own ideas or making their own decisions about investing. Followers may lack interest and/or knowledge of the financial markets and their decision-making process may lack a long-term plan.

Common Issues with Followers: The herd mentality is a concept of investors piling into the same investments as others. This is often the basis of investment bubbles and subsequent crashes in the stock market. When you are a follower, you are typically following fund managers who have tools and recourses to act on new information in a fraction of a second. By the time the average investor “follows” them into a position, it is often too late. It is always important to understand your investment decisions and how they fit into your overall plan.

Independents

Independents are investors who have original ideas about investing and like to be involved in the investment process. Unlike followers, they are very interested in the process of investing, and are engaged in the financial markets. Many Independents are analytical and critical thinkers and trust themselves to make confident and informed decisions, but risk the pitfalls of only following their own research.

Common Issues with Independents: Similar to overconfidence bias associated with accumulators, independents face similar issues with relying too heavily on their own train of thought. We as humans have ability to convince ourselves that we are correct or that we don’t need guidance, even when that is not the case.

 

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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