Protect Yourself From Yourself: 5 Investing Biases to Know

Dan Wiener:
You just cannot watch TV and respond to this stuff with your portfolio. Watch it for entertainment, which is about what it is.

Josh Jones:
Right.

Dan Wiener:
Don’t go trading your portfolio based on it.

Josh Jones:
Hi everyone, this is Josh Jones, a vice president at Adviser Investments. Welcome back to another episode of The Adviser You Can Talk To Podcast. I’m joined by Dan Wiener, chairman and founder of Adviser Investments. Hi Dan.

Dan Wiener:
Hi Josh. Thanks for intro-ing this podcast for us. This is going to be a lot of fun.

Josh Jones:
This is going to be a lot of fun. Well, today we’re going to be talking about investor behavior rather than the economy or the markets. We’ll dive into five behavior biases that we all face as humans when investing our money and how to recognize those biases and turn them around to help improve our investment behavior.

Dan Wiener:
These are sort of bad biases, don’t you think? I mean there are good biases, but I think most of these investing biases tend to be bad ones.

Josh Jones:
We’ll hopefully turn them around and make them good.

Dan Wiener:
I hope so. Let’s get into it, Josh, come on.

Josh Jones:
All right, here we go. The five behavioral biases that we’re going to talk about: Recency bias, confirmation bias, hindsight bias, regret-aversion bias…

Dan Wiener:
That’s a long one.

Josh Jones:
That is a long one… and the disposition effect.

Dan Wiener:
Start us off, Josh, tell me about recency bias, because that’s the one we hear about all the time.

Josh Jones:
All right, well why don’t I start off with a recent story then if we’re going to go recency bias.

Dan Wiener:
Okay.

Josh Jones:
Imagine for a minute that it’s the end of 2018. Stocks are falling in the fourth quarter, and by Christmas Eve, the Dow and the S&P 500 are down like 20%, Dan. Smaller stocks and tech stocks, they’re down a lot more. The media at the time, screaming about bear markets and the fact that the U.S. economy is slowing. Our trade skirmish with China would turn into a trade war. Government has just shut down. Interest rates are all over the place. The president said the Federal Reserve was going to raise interest rates, and should cut them instead. It was almost like a perfect storm of negative news. The thought, of course, was that the market was going to keep going down, right?

Dan Wiener:
Yeah, absolutely. These folks have a recency bias based on the most recent headlines, what has happened in the news in the last day, the last week, what they’ve heard about on TV. What they’re reading about in the paper. We have this tendency to be either over optimistic or overly fearful. A lot of studies show that loss aversion is a much bigger impact on us than the potential for profits. Recency bias, I guess, is strongest when the news is negative.

Josh Jones:
Today there’s no shortage of negative headlines. What would you tell Dan, investors that are focused on those headlines?

Dan Wiener:
I guess, you have to realize, if we go back to this notion that we are much more fearful than we are optimistic. From an investor’s standpoint, we’re much more fearful of losing money than we are optimistic about earning profits. You have to start to sit back and say, “First of all, I’m an investor. I have to realize that losses are a fact of life. Losses are going to happen in the course of my investing lifetime, and they don’t have to be permanent losses.”

Dan Wiener:
We have done studies here, our research team has studied this and on average you see a 14% decline every year in the stock markets. Believe me, when the markets are down 14%, people get really anxious. We have a very strong flight instinct. We want to stand up and run, and you really have to take control of your emotions here and reassess. What is your risk tolerance? If you want to run, that must mean that you’re overly exposed to the stock market, so back off a little bit. Don’t let recent headlines drive your investment strategy or your objectives. It doesn’t work that way.

Josh Jones:
Right. We’ll often tell the families we help too during periods like this, that those feelings you have are totally normal. I feel like a big part of our responsibility in helping them is to make sure they don’t act on those feelings and those impulses.

Dan Wiener:
Yeah. We had a client during 2008, who would watch CNBC every morning as he was getting dressed. The headlines and the commentators on CNBC were so negative that the client went out and sold everything they owned, and then began buying bank stocks. I’m not sure why, except that they probably saw someone on CNBC talking about how the banks were going to rise up and outperform because they’d been hit so hard. This client lost so much money in these bank stocks and sort of came back to us at one point and said, “Listen, I made a big mistake here. Could you take care of my portfolio again?” We did.

Dan Wiener:
I also threatened to go over there and rip the cable out of their wall, because I said, “You just cannot watch TV and respond to this stuff with your portfolio. Watch it for entertainment, which is about what it is. Don’t go trading your portfolio based on it.”

Josh Jones:
Well, it reminds me of what Fidelity Magellan’s famous portfolio manager Peter Lynch would say. That is, the key to making money in stocks over time is to not get scared out of them during those inevitable tough periods. I think back to when I was a kid, I remember my dad always saying, “Hey, it’s not a loss unless you sell. It’s just a temporary decline.”

Dan Wiener:
That’s exactly right. That’s exactly right. We have a motto here, “Time in the market, not market timing.” Really, you can’t make money in stocks if you’re not in them. What’s that lottery line? You got to be in it to win it?

Josh Jones:
Yeah.

Dan Wiener:
Well, you got to be in the stock market if you’re going to make money in stocks.

Josh Jones:
Yeah. Well, hey Dan, when you combine recency with our second behavior bias, confirmation bias, you can see why investors have to be really careful about paying too much attention to the headlines. When I think of confirmation bias, it’s the tendency for us to focus on things we already believe to be true. We’re all guilty of it. I mean, I’m a perfect example. I’ve been in the Boston area now for over 20 years.

Dan Wiener:
Oh here it comes, the sports analogy.

Josh Jones:
It’s the best, right? We’ve got the Patriots, we’ve got the Celtics, the Bruins, the Red Sox. Come on, you’re not along for the ride?

Dan Wiener:
Yeah, I’m along for the ride, but I’m not going to let winning one game confirm that all games are going to lead to the World Series championship or the Super Bowl. You have to be able to avoid confirmation bias a little bit by looking for, and I’m going to go back to the stock markets, because I can’t talk sports.

Dan Wiener:
Someone’s got to play devil’s advocate from time to time. You have to at least understand arguments that don’t confirm what you believe in. Listen to the arguments. You can disagree with them, but at least understand another point of view. This is true in politics. It’s true in investing.

Dan Wiener:
From an investment standpoint, here at Adviser Investments, we’ve got a team of almost a dozen professionals, who have different viewpoints on things like interest rates, on stock prices. Particularly when stocks are at a peak, when interest rates are at all-time lows or bond prices are at all-time highs, you have a difference of opinion among people about whether the next leg is up or down. We have to really discuss that, debate that, but often it means just stepping back for a minute and considering all the options.

Josh Jones:
Why I think it applies too when we’re speaking with the families we help. I’ve always felt a big part of our job is to be that person that our clients can bounce ideas off of, when they’re thinking about making major financial or investment decisions. It’s sort of like we’re a financial coach. Watched a bunch of tennis over the summer, and you see some of these top tennis players in the world, all of the top tennis players in the world. I had to go back to sports Dan for a minute.

Dan Wiener:
Of course, you did.

Josh Jones:
They all have these coaches that help in so many ways. I think one of the ways in which we help as far as being a financial coach is concerned, is to try and put things into perspective. Provide an outside and hopefully an emotional perspective when helping families make decisions.

Dan Wiener:
This confirmation bias has a lot in common with another behavioral bias, which is hindsight bias. We all know the saying, hindsight’s 20/20. Well, almost everything is crystal clear in hindsight. We always think that things which happened in the past were easy to predict. The situations or actions leading up to them seem so obvious now. I mean, if you think back to the 2008, 2009 financial crisis, when you look at what was going on in the mortgage lending business back then, you can see it crystal clear now. It wasn’t crystal clear back then, and that of course is what drove the financial crisis.

Dan Wiener:
This leads investors to believe having such a strong hindsight bias, it leads you to believe you can predict the future. The reality is, the future is very tough to predict. As a financial adviser and you’re talking to families all the time, where do you come across hindsight bias?

Josh Jones:
You started to touch on it, Dan, the financial crisis or the bursting of the technology bubble almost 20 years ago. Those are two perfect examples. Of course, now in hindsight, we know that they were both going to take place.

Dan Wiener:
Yeah, 50 P-Es on the tech stocks, right? Except that everybody thought the P-E was going to go from 50 to 75.

Josh Jones:
Well, you know, it was an interesting time when you’d get a call saying, “Hey, my a son or daughter is getting married in six months, I need a few more bucks. What stocks should I invest in?”

Dan Wiener:
Oh perfect. Yeah.

Josh Jones:
You think back over 10 years ago now, and in hindsight we now know a bubble in the real estate market, in the creation and sale of these subprime loans was at least one big catalyst for the economies and the markets tumble. Lots of articles about house flippers and the ease which everybody from your shoe shine person to the cabby was becoming a real estate investor. No one at the time was able to put those pieces together.

Dan Wiener:
There seem to be about 10 times as many people who claim to have seen this today as was actually the case back then. I don’t listen to those who claim to have foreseen this, because unless they show me their investment statements, I’m not going to take it.

Josh Jones:
Well you know it’s interesting too. I mean even for people that claim to have seen it, trying to make an investment decision based on what you think is going to happen and how the markets are going to react, that’s a whole separate story.

Dan Wiener:
Right.

Josh Jones:
Well, hey, the financial crisis brings up our fourth bias, regret aversion bias. This occurs when we’re facing a decision in a word we might come to regret the decision we make. We’re so focused on avoiding the feeling of regret, we tend to get paralyzed, and a lot of times not make a decision at all.

Dan Wiener:
You don’t have any regrets, do you Josh?

Josh Jones:
Oh Dan, we don’t want to go down that path.

Dan Wiener:
I know, but you probably regret doing this podcast with me right about now. Yeah, this goes back to what I talked about before, which is that, we as humans are much more fearful. Our fear instinct, our flight instinct is much stronger than our optimistic instincts. We don’t want to have regrets. I’m sure you come across this working with our clients as well.

Josh Jones:
We see it all the time. In fact, recently Dan, we’ve had a number of folks who we’ve started helping, who wanted to be invested in the stock market. Had plenty of cash to invest, but they’re just really nervous and worried about these recent headlines.

Dan Wiener:
Yeah. They don’t want to put their money in and see in one month that it’s down and then have all these regrets, right?

Josh Jones:
Right.

Dan Wiener:
I mean it’s a very short-term. It’s kind of a short-term bias if you think about it, because over the long haul, you’re not going to remember what you did two or three years ago. Boy, if I give you that money and say, “Put it in today, let’s get going.” We have a lousy month or even a lousy quarter, like the fourth quarter of 2018, you’re going to say, “Oh my gosh, what did I do?”

Josh Jones:
I can’t believe it.

Dan Wiener:
I try to avoid it.

Josh Jones:
Yeah, I can’t believe I did it. Well, it’s funny, you’re right. These short-term decisions that long-term have very small impacts. I think back a little over 30 years ago now, 1987, the market crash. Obviously a huge deal back then, but it’s amazing how far the markets have come. I think we had a Dow Jones at probably around 1800, 1900 and here we are today close to [crosstalk 00:14:57].

Dan Wiener:
Well, if you take a look at a line that shows you the progress of the S&P or the progress of the Dow, the 1987, one day market drop barely shows up. It’s a blip, but of course it was a huge deal on the day. I was actually at the New York stock exchange on October 19th. They called us in and wanted to tell us that the markets were okay.

Dan Wiener:
I’m sure you come across regret aversion bias when clients come in with something in their portfolio that they’ve had for a long time that’s underperformed. The recent examples might’ve been GE stock or something like that. I mean, how do you deal with that? The client comes in, they’ve owned a stock for a long time. They’ve got a loss, but they don’t want to sell it, because, gosh, it could go up tomorrow. How do you deal with that?

Josh Jones:
Well, a question that we like to ask in those situations is, “Hey, imagine for a minute that you didn’t own this particular stock, and you were starting from scratch today. Would you want to own that position?” This ties nicely into our fifth and final behavior bias, the disposition effect. This is really just the tendency we have to put a higher value on something that we own then it’s actually worth, because we own it.

Josh Jones:
If you ever watch HGTV, for example, there are countless examples of couples looking to sell their home. They always seem to believe the home is worth way more than it actually is.

Dan Wiener:
It goes back to that question that I like to ask, which is, if you sold this stock or the fund today, for whatever it’s worth, would you take the money and buy it back tomorrow? Would that be the best use of your money? If the answer is no, then we should probably just sell it and move on. Right?

Josh Jones:
Right. Well, I think that’s good advice. When we look at all five of these behavior biases, recency, confirmation, hindsight, regret aversion, and the disposition effect, I think a few common themes jump out. Any that come to mind to you, Dan?

Dan Wiener:
Well, I think that investors often are trying to avoid making a mistake. At the same time, they’re also looking for the next big thing. If you’ve ever played tennis or golf and you’ve lost a match…

Josh Jones:
You had to bring it back to sports, didn’t you?

Dan Wiener:
I did. I did. You should have won, you could have won. Lots of times the person that wins isn’t necessarily the best player, but it’s the person who makes the fewest mistakes. You try to avoid, as an investor, you try to avoid allowing these biases to create unforced errors, right? Did I get that term, right, unforced errors?

Josh Jones:
That sounds good to me.

Dan Wiener:
Okay, well you’re the sports guy. I’m not, I’m not. You don’t want to have unforced errors. You don’t want to let your biases grab hold of you and make you do things that you shouldn’t with your portfolio. Often that means sitting on your hands. The desire to do something is often your biggest enemy when it comes to investing.

Josh Jones:
All right, well, I think a lot of these can be easier said than done, which is why it takes a lot of work. Controlling our behavior as investors, it’s something we actually have control over, unlike what the market’s going to do on a day to day or week to week basis. A term we use around the office is having an investor’s mindset. In other words, being prepared financially and psychologically for regular temporary drops in the market. Asking ourselves, “All right, why am I investing and what’s the purpose of my money?” Remembering too, we’re running a 10K race, so let’s not measure our progress by each 100-meter lap.

Dan Wiener:
Yeah, I like to think of it more as a marathon. 10K’s just aren’t long enough. If you’re investing for your retirement or even if you’re investing for your children’s education, or buying that second home, often these are marathons. You really have to pace yourself. We tend as humans to have biases of overconfidence. We think we’re all Warren Buffetts like my client friend, who was trading into financial stocks during the financial crisis, because he was watching too much CNBC.

Dan Wiener:
We’re more like the brothers, Mortimer and Randolph Duke in the movie “Trading Places.” They thought they knew more than they did, and they lost their shirts, betting real money on it. We’re not Warren Buffetts, but we don’t want to be the Dukes.

Josh Jones:
All right, well, hey, it sounds like being smart doesn’t necessarily make you a great investor. It’s probably more about, or it is more about being disciplined and thinking rationally. I think of Sir Isaac Newton when he quipped, “I can calculate the movement of stars, but not the madness of men.” When he was referring to the South Sea Company bubble of the early 1700s, and had just lost 90% of his money.

Dan Wiener:
Right. Well, human nature and irrational thinking, it all comes together. The beauty of being successful with your finances and your investing is, you don’t have to be a rocket scientist. In fact, I’ve met a couple of rocket scientists who were lousy investors. Many of our most successful clients live very uncomplicated lives. They know what they’re trying to accomplish. They know what their objectives are. They don’t risk what they have and need for what they don’t have and they don’t need. That’s really what it’s all about.

Josh Jones:
I think that’s a great place to end it. It’s been great talking with you, Dan, about investor behavior and how to overcome bias when we’re making investment decisions. This has been Josh Jones and Dan Wiener of Adviser Investments. Thank you for tuning into another episode of The Adviser You Can Talk To Podcast.

Josh Jones:
If you’ve enjoyed this conversation, please subscribe and review our show. You can also check us out at adviserinvestments.com/podcasts. Your feedback is what drives so many of the topics that we cover here, so it’s always welcome. If you have any questions about this episode or perhaps topics or ideas for future episodes, we’d love it if you emailed us at info@adviserinvestments.com. Again, that’s info@adviserinvestments.com. Thanks again for listening.

Dan Wiener:
Josh, we’re just going to have to talk about your regret aversion of bias dealing with me on a podcast.

Josh Jones:
That might be a whole separate series we do, Dan.

Dan Wiener:
We could think about that. Thanks, everybody.