The Value of Behavioral Coaching
May 08, 2018 | Frank Sakellariou
As you know, an investment advisor manages your wealth by using investment strategies and financial planning initiatives. The advisor evaluates each client’s situation to develop a comprehensive financial plan and through in depth market analysis provide you with investment recommendations. But the biggest challenge for an advisor and the area where the best advisors add additional value is through the management of emotions and behavioral coaching.
Advisors help their clients ignore market “noise” by establishing a long term investment thesis with an appropriate level of conviction, not letting short term market events derail you from your true financial goals.
We are all human, which means that sooner or later we will exhibit particular human cognitive biases that will force us to implement decisions that are harmful to our investment goals. We tend to assume certain things automatically without taking the time to logically think about them.
Daniel Kahneman, professor of behavioral & cognitive psychology at Princeton and winner of the 2002 Nobel Prize for economics explains the biases in our intuition in his best-selling book, Thinking Fast & Slow. Below, we highlight some of his most interesting quotes and explain four particular biases that we see frequently amongst investors.
Overconfidence Bias – “The illusion of understanding”
As the name suggests, this explains the fact that humans tend to overestimate the value of their own individual judgment.
“Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance,” (page 201).
The illusion of understanding can also be explained by the Hindsight Bias - the illusion that events that already took place appear to have been predictable even though no evidence existed prior to the event.
“We are prone to blame decision makers for good decisions that worked out badly and to give them too little credit for successful moves that appear obvious only after the fact.” (Page 203)
Confirmation Bias – “A Machine for Jumping to Conclusions”
Neuroscience research has shown that we get real physical pleasure when we come across information that supports our own views. This leads investors to seek only information that supports their thesis and ignore potentially useful information that opposes.
“Jumping to conclusions is risky when the situation is unfamiliar, the stakes are high, and there is no time to collect more information,” (page 79).
Loss Aversion Bias – “Losses loom larger than gains”
Research has shown that people feel the pain of losing, about twice as much as the pleasure of gaining.
In a recent interview with Bloomberg’s Bary Ritholtz, Daniel Khaneman explains that this phenomenon is rooted in our evolution.
“...You would imagine in evolution that threats are more important than opportunities. And so it’s a very general phenomenon that bad things sort of preempt or are stronger than good things in our experience. So loss aversion is a special case of something much broader.”
“So if there is a deer in your sights and a lion, you are going to be busy about the lion and not the deer.”
Tendency of anchoring our entire frame of thought on the first piece of information (anchor) we received. This tendency blinds us from more potentially important information, dramatically increasing the risk in a portfolio.
“Built in tendency that we have of trying to make sense of everything we encounter”
Understanding our own cognitive bias can give us insights into why people act the way they do and why markets move the way they do. It’s important to never allow our human impulses to dictate the direction of our thesis and instead rely on a diligent analysis before making decisions. It’s our job to help you navigate uncertainty and to try to minimize the risks that arise through the introduction of one’s own human bias into the investment decision making process.