Guard against be­havioural bi­ases cloud­ing your fi­nan­cial de­ci­sions

Weekend Argus (Saturday Edition) - - FRONT PAGE -

WE OF­TEN blame our emo­tions when we ex­er­cise poor judg­ment, and, con­trary to what we may be­lieve, our fi­nan­cial de­ci­sions are not based purely on log­i­cal de­duc­tions.

Re­search has shown that our fi­nan­cial plan­ning can be im­paired by be­havioural bi­ases. The most com­mon bi­ases are: • Re­search has found that in­vestors tend to be more dis­pleased if their in­vest­ment makes a loss than they are pleased if their in­vest­ment grows by the same per­cent­age. This phe­nom­e­non can have a paralysing ef­fect on in­vestors, be­cause their fear of a pos­si­ble mar­ket down­turn re­sults in their not in­vest­ing at all, and so they lose out on po­ten­tial to earn in­vest­ment growth. • This prompts in­vestors to be drawn to in­for­ma­tion that con­firms their al­ready-held con­vic­tions, even though the in­for­ma­tion may not ap­ply to their par­tic­u­lar cir­cum­stances. An ex­am­ple is where an in­vestor fo­cuses on the re­turns gen­er­ated by a spe­cific as­set class over a lim­ited pe­riod and ig­nores the other prin­ci­ples of port­fo­lio con­struc­tion. • This is when in­vestors view money com­ing from dif­fer­ent sources as dis­sim­i­lar. In Afrikaans we have a proverb “er­fgeld is swer­fgeld”, which means that heirs tend to spend the money they in­herit faster than the money they earn. All money, how­ever it is ac­quired, should be man­aged ac­cord­ing to the same in­vest­ment prin­ci­ples, to en­sure a healthy port­fo­lio. • This bias can usu­ally be spot­ted when in­vestors say “I should be able to”. In­vestors are con­vinced they can pick the best shares, time the mar­ket per­fectly or recog­nise the best in­vest­ment prop­erty. • We are all prone to make de­ci­sions based on favourable events in the re­cent past. In­vestors of­ten pour money into the lat­est top-per­form­ing fund, as­sum­ing that past per­form­ing is an in­di­ca­tor of good re­turns in fu­ture. • This bias can be summed up by the well-known phrase “I knew that would hap­pen”. It is the ten­dency for peo­ple to be­lieve that a past event was pre­dictable. This men­tal state can re­sult in in­vestors be­com­ing too reliant on pre­dic­tions and con­struct­ing port­fo­lios with too much risk. • Go­ing along what other peo­ple are do­ing with­out mak­ing your own as­sess­ment of the sit­u­a­tion can re­sult in your in­clud­ing in­vest­ments in your port­fo­lio that are not aligned with your goals and ob­jec­tives. How can we avoid these po­ten­tial pit­falls? The first step is to ac­knowl­edge that we are prone to be­havioural bi­ases and to guard against them when mak­ing fi­nan­cial de­ci­sions. Sec­ond, hav­ing a fi­nan­cial plan­ner with whom we can share our feel­ings can help us to avoid these bi­ases. Hester van der Merwe is a fi­nan­cial plan­ner with Ul­tima Fi­nan­cial Plan­ners in Jo­han­nes­burg. She is an ac­cred­ited Cer­ti­fied Fi­nan­cial Plan­ner.

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