In the more distant past, I would be highly speculative with my investment choices…often resulting in a string of ill-advised investments! Whilst not perfect now, I have evolved certain rules and approaches that I now follow that have helped me to overcome my own personal tendencies to invest with certain biases. Today, I shall share some of what I now understand to be investor personality and investment decision biases that can shape our investment decisions, often for worse, unless we are aware of them and can manage them to correct them.
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Today’s must do’s
Identify your investor personality and your most common investment decision biases. Then, go and plug your gaps! Set up rules, processes and systems to help to combat the behavioural, emotional and informational tendencies that can sometimes lead to making poor investment decisions. Ask me for help if you want.
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Transcription of the show
Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and, as always, it’s a pleasure to have you join me on the show again today.
I recently had lunch with a Ankur, a property buddy of mine. He is a real gent but that’s not exactly the point of today’s share. However, fully demonstrating that he is indeed a gent, Ankur later dropped me a note of thanks for the time and info shared during our lunch meet. He also included a link to an article on investment bias as a way of sharing information and adding further value to our relationship.
I am aware of investment bias in general terms, but to be perfectly honest with you, am no expert on the topic. What I can now tell you is that I have learnt over time that I did have a tendency to act in certain ways when it came to my investing decisions. Things have changed over time, particularly as I have learnt that my natural tendencies were not always helpful!
Today’s episode is aimed at opening up this discussion on investor personality and investment decision bias just a little, so let’s get on to that right now then.
The original article link that Ankur shared with me was called: These Five Cognitive Biases Hurt Investors the Most and I have added a link to this in the show notes for you. However, within this article was a link to an infographic that contained 188 different biases that can influence our investment decisions and behaviour. That’s probably way too many to learn, let alone master, so today I plan to cover just 12 of the main investment biases that are common for us to experience.
In addition to these 12 biases, there are also four different investor personality types. If we can understand our investor personality types preference, we are also more likely to understand some of the associated investment biases that we are likely to experience. So, we shall start with investor personality type now.
The CFA Institute is a global organisation that sets standards for investment professionals, including an accreditation program that addresses 21 of the approximate 188 investment biases that could exist. The CFA Institute also identified 4 different investor personality types from a range of research. These investor personalities are known as: Preservers, Accumulators, Followers and Independents. Let’s take a quick look at these now, with a full credit disclosure going to Investopedia to assist with the explanations. Source.
Preservers are investors who place a great deal of emphasis on financial security and on preserving wealth rather than taking risks to grow wealth. Preservers watch closely over their assets and are anxious about losses and short-term performance. Preservers also have trouble taking action for fear of making the wrong investments decisions.
Accumulators are investors who are interested in accumulating wealth and are confident they can do so. Accumulators tend to want to steer the ship when it comes to making investment decisions. They are risk takers and typically believe that whatever path they choose is the correct one. Accumulators have frequently been successful in prior business endeavours and are confident that they will make successful investors as well.
Followers are investors who tend to follow the lead of their friends and colleagues, a general investing fad, or the status quo, rather than having their own ideas or making their own decisions about investing. Followers may lack interest and/or knowledge of the financial markets and their decision-making process may lack a long-term plan.
Independents are investors who have original ideas about investing and like to be involved in the investment process. Unlike followers, they are very interested in the process of investing, and are engaged in the financial markets. Many Independents are analytical and critical thinkers and trust themselves to make confident and informed decisions, but risk the pitfalls of only following their own research.
You might already be able to identify with one of these investor personality types. If you did, then here are some of the typical investment biases that could accompany these investor personality types:
Preservers – tend to have heavy focus on short-term results, at the expense of mid-to-long-term performance. This could lead to some emotional, knee-jerk decisions such as selling up in a crash out of fear, for example. Preservers can also be investment procrastinators. So, if you are taking your time starting or fall into a blind panic if house price data shows a downward shift, then this could be you!
Accumulators – overconfidence is one of the biggest tendencies with an Accumulator. They may become overconfident in their own ability to pick a winner and market trends, sometimes leading to getting caught out if the pattern is broken. So, if you feel that you are most likely to make the right investment decisions, sometimes believing others who act differently to be wrong and also like to heavily control the investment process as an active investor, then this could be you!
Followers – the herd mentality is one of the biggest tendencies of the Follower. Similar to the Preserver, they can follow the masses or a big name into a position, without always undertaking their own research. This is often what happens in the boom and bust cycle, where Followers compound the swings in a market for example. So, if you see recent results, which gives you either a sense of fear or potential loss and want to sell, or a sense of potential gain and want to buy, or if you tend to think you will do what your family or the big market commentators are doing, then this could be you!
Independents – similar to the overconfidence issue for Accumulators is a tendency to use confirmation bias in the case of Independents. This is where we zone into information and data that might support our original pre-conceived ideas, rather than being open to all data sources. So, if you adopt an investment view or position and then seem to find lots of data to support that view and less that contradicts it, or tend to prefer to look at certain types of investment only, then this could be you!
It does not automatically follow that these tendencies will always exist with each of these personality types and in some cases, the tendency can lead to a strength rather than a weakness, under the right conditions.
Personally, I am probably inclined to be an Accumulator. However, over time I have added in elements of the Independent and Preserver personalities to help counter some of the potential flaws in the Accumulator personality alone.
OK, so that’s the personality type, now let’s look at 12 of the key investment biases that we are likely to encounter as property investors. Whilst some of these might tend to accompany certain investor personality types, it could be the case that we possess some that might fall under other personality types or others that could arise irrespective of investor personality type as well.
- Recency Bias – this is where recent events lead to a view that it will always be like this. This is probably more common with new or younger investors. The highs of 2007 or the crash of 2008 could significantly sway your views if you suffer with this bias. The best way to overcome this is to deliberately study long-term trends and events from credible sources to understand how and why all markets change over time.
- Loss Aversion Bias – this is a fear or loss or regret for an investment, it could also come in the form of ‘buyer’s remorse’ after you make an investment purchase. This can be extremely emotional and so very hard to resist, as it can literally grip the investor and stop them from acting. However, not acting can also carry risks of loss. For example, putting all your cash under the mattress could lead to under-performing returns, or even total loss in extreme cases, especially if the mattress is stolen! Alternatively, consider if the Government seizes certain asset types or currency accounts, as happened in certain developing countries several times historically. The best way to overcome this is to have a system of due diligence checks and investment rules to follow and allow the process to work rather than the emotions. Also, spread your investment portfolio around a little to help dilute potential losses.
- Herd Mentality – Buy low, sell high as the saying goes and yet the markets seem to behave in the opposite pattern, with people piling in at the top of the market and dumping assets at the bottom…just because everybody else is! The best way to overcome this is to do your own research, then resist reviewing your portfolio so frequently. Limit major portfolio reviews to once a year and you will ride out around 364 daily market updates and cues to act fast along with the herd!
- Optimism Bias – do you believe that you of above average intelligence, a good driver or a great lover? Most surveys suggest that more people overestimate their capabilities compared to the average performer. If you tend to think you are above average in many things, then you might just suffer from this overconfidence bias. After all, we can’t all be above average, can we? This suggests that our subjective assessment of our performance is often far greater than our objective The best way to avoid this is to measure our investment results in a conventional way and then track the results over time. The numbers don’t lie…unless you fudge them obviously! Do you beat the market averages of not?
- Self-attribution Bias – this is a tendency to take the credit for the good results and transfer the blame to outside events and people for the bad results. Results are rarely 100% down to only our own actions. Good and bad results can also be influenced by timing, luck, regulation, trends, competition, economic factors and so on. So, a healthy dollop of self-modesty and objective assessment over time can help to put things into their correct perspective.
- Choice Paralysis – this is where the sheer level of options available can drive us into a state of ‘analysis paralysis’, such that we end up doing nothing at all. I recently wrote an article for Your Property Network Magazine which describes 40 different ways to profit though property. Picking the right one among 40 can be so overwhelming that we could end up delaying our investing altogether. The best way to overcome this is to set a limit on the research phase, focus on the top 3-5 investment strategies and then have a deadline for when to start investing…with or without having perfect information!
- Mental Accounting – I have included this one as it could apply in certain situations. This is where we attach different perceived value to certain sums of money depending on how it came about. For example, income from employment might come with a higher perceived value than say a gift, inheritance or other windfall. As a result, we might be less rigorous with money from one source than from another. The easiest way to overcome this is to have set investment criteria, no matter where the funds have come from, in order to neutralise the ‘free money effect’.
- Confirmation Bias – The best way to illustrate this is to recall when you decided to buy a certain car. Suddenly you see them everywhere and that’s because you are now conscious of them and so actively look for them. The same tendency can happen with research data and other information collation. Trust me, if you only ever see info fully supporting or fully undermining an investment case, then you may be suffering from this confirmation bias! The best fix is to force yourself to compile a list of both positive and negative sources of information in the first place. Then, you can evaluate the list of pluses and minuses a little more objectively…well, hopefully!
- The Narrative Fallacy – This is where there is a tendency to listen to stories rather than study hard data. If you rely purely on the newspapers for your data sources, then you could easily be falling victim of this particular bias! Independent data collation and analysis is harder and also takes time, but it is well worth doing. One way that I try to avoid this is by having a list of key economic, housing and financial data compiled every month and sent to me by my assistant. I look at the list each month and try to make sense of what it is telling me rather than all of the propaganda from some news corporation with an agenda to spin.
- Endowment Bias – this is almost the opposite of loss aversion bias and where we overvalue the assets or investments that we actually hold. It can come from over familiarity or a local level of knowledge, for example. We might have decided that a certain property, location or strategy is the best for us at some point, but is that still the case with the passage of time? The best way to fix this is to produce objective investment performance data and then track this over time. Couple this with our initial investment criteria, and then we can benchmark our current asset performance against a set of objective criteria we have set for ourselves some time before. We might then see these assets in a different light.
- Illusion of Control Bias – This one was quite familiar to me, it is where we believe that it is better that we are in control of where our money is invested, believing that we will do better than the market average. The fact of the matter is that we cannot control entire markets, economic situations, Government policy and regulation and such like, so it can therefore lead to a kind of overconfidence. The best way to overcome this with property is by forcing appreciation, ensuring you invest with a positive cashflow and then diversifying. Over time, we can diversify across properties, strategies, geographies and other asset classes. This at least helps to spread the risk of control bias around a little. By forcing the appreciation instead of trying to predict capital growth, we do actually regain an element of genuine control too.
- The Bias Blind Spot – This is quite simply the situation where we don’t know what we don’t know! We all have our biases, prejudices or tendencies, but we might not know what they are in the first place. I have often said that one of my top tips is to seek to plug our gaps. Of course, this starts by identifying what our gaps are in the first place. If nothing else, covering the four investor personality types and 12 of the 188 investment biases should help on this level. Personally, I have found that getting an objective insight into our potential gaps can be extremely helpful. Use this list of investment biases as a kind of checklist or get someone to help you identify your gaps instead. I have just undertaken a similar exercise with one of my mentees, who was unable to fully identify their gaps prior to talking them through with me over a hour or so. Once identified, they are then aware of them and can also plan to plug these gaps going forward.
In all honesty, I find this kind of investment psychology or ‘behavioural finance’ insight fascinating. I only wish I understood it better when I was younger. I remember that time when I won a small packet at a casino, only to become overconfident and lose not only my initial gains, but also my initial stake and some more money many moons ago. This was a panful reminder of what can happen when you don’t understand what your investment biases are. Since then, and in particular, over the past 5 years or so, I have developed a range of techniques, simple systems and practices that help me to overcome my natural tendencies and biases.
For example, I have developed pre-set investment criteria and a checklist scoring system for a particular property and strategy. I measure my portfolio performance but only review this at key dates, in addition, I follow and track hard data sources. I now diversify my investments in several ways, hold certain assets for the long-term wealth and others that I know will be shorter-term income plays and I adopt a kind of pound-cost averaging among other techniques. I talked last time about some of the ways in which I try to de-risk my property investment portfolio and today’s topic builds on this to some extent.
So, what about you…which of the four investor personality types do you most relate to and more importantly, how many of the 12 investment decision biases did you find yourself nodding along to? Take a look at the show notes and use these 12 investment biases as a kind of self-evaluation checklist, then work out how you will adopt some rules, processes or techniques of your own to help to overcome these biases.
If you want any support on identifying your gaps, generally as a property investor, then drop me a line and perhaps we can have a chat about how best to do that. I hope this has been helpful to you, but please also remember that this episode just scratches the surface on this topic. I have referenced around 7 separate article links that I used to help me produce today’s show, so make sure you check out the resource links in the show notes to see where else to go to understand more on this subject.
Meanwhile and as usual, email me firstname.lastname@example.org if you want to talk about anything from today’s show or more generally in property investing. Also, the show notes will be over at the website www.thepropertyvoice.net
But for now, all I want to say is thank you very much for listening once again this week and until next time on The Property Voice Podcast…it’s ciao ciao.