Reading Between the Lines of Investor Biases

Bolhuis, Michelle; Goodman, Ned
January 2005
Journal of Financial Planning;Jan2005, Vol. 18 Issue 1, p62
Academic Journal
• It's clear that it's impossible to predict what is going to happen in the stock market in the short term, yet many intelligent investors make investment decisions based on short-term market forecasts made by forecasters, journalists, and others. Why? One reason is that people are hardwired from evolution to seek patterns in order to explain our world. These patterns are dependent on context and transitory perceptual conditions, and are highly subject to personal memories and recent background noise. • The challenge investors face has less to do with gaining information than what to do with the information once gained. Most people are systematically biased when it comes to making investment decisions, and those biases are built from bad memories and are anchored to old precepts. • Biases that clients have include over-confidence, unbounded optimism, loss aversion, hindsight, and mental accounting. • Managing client actions and decisions in light of these biases is the most critical role planners can play in a relationship, far more important than picking great funds or hot stocks. • Planners need to recognize that built-in biases, emotional reactions, and unrealistic expectations exist within their clients, and they need to improve their ability to "read between the lines" when clients don't always say what they mean and don't do what they say. • Financial planners need to bring mental discipline to their clients, much as great coaches and great athletes have mental discipline. Planners also need to employ strategies such as dollar-cost averaging that compensate for some of these biases. INSET: Executive Summary.


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