Are you a better-than-average driver? Regardless of what my wife says, I know I am, and chances are you think you are too. That is because nearly three-quarters of people think they are better-than-average drivers. Besides being mathematically impossible, this statistic is an example of overconfidence—and is just one illustration of how certain biases can influence our thought patterns.
When we return, we will look at three of the most common behavioral biases we see when working with investors, Anchoring, Recency Bias, and of course, Overconfidence. And believe me, we all fall victim to them at some point.
Welcome back, let’s dive right in…
Let’s first discuss anchoring. Anchoring is when you assign too much weight to a convenient baseline piece of information, ignoring future information that does not align with the anchor. We see this with investors and ‘all-time market highs.’ People are anchoring to the current all-time high, thinking this is the ceiling. By definition of compound growth, markets continue to touch new highs over time. Otherwise, the expectation is that future corporate cash flows are always flat or declining. Just being aware of this bias is one step in avoiding it.
Next, let’s talk about Recency Bias. Recency bias can lead to putting too much emphasis on the latest information – and often ignoring other important data. We see this with investors during volatile or declining markets. Investors look at recent market performance and events and extrapolate this over the long haul, ignoring long term trends in the market which have rewarded investors.
Last, I want to discuss overconfidence. However, don’t confuse this with confidence. Confidence is useful and, in many cases, necessary. For example, it takes confidence to stand in front of this camera. Overconfidence, however, can be dangerous. We commonly see this in investors who have had recent success with a hand full of individual stocks. This bias can cause these investors to feel they have more information than they really do, which can lead them to make emotional decisions in response to market moves. Such as timing. And while not impossible, a majority of people do not succeed over the long term with this strategy. Try tracking ALL of your investment decisions to see if you really are consistently achieving the returns you think you are.
At Austin Asset, we sometimes joke we are therapists with spreadsheets. And, if you are seeing these biases play out for you, give us a call and come sit on our couch.