Who else is sick of seeing ‘New Year, New You!’ Nothing fundamentally has changed between New Years Eve and that very fine January morning. Instead of focusing on becoming a new you, we think your efforts should be directed towards developing a better understanding of you. One way to do that is by acknowledging our biases, especially our money biases.
We want to turn your attention to the natural biases we possess with money. We find that if we recognize things for what they are, we tend to make better decisions going forward. This is by no means intended to diagnose anyone. Instead, we hope to inform you about the financial biases that exist so that you can be more aware in what guides your money decisions (and reactions!).
Over the next five weeks, each blog will educate you on two money biases, what they can lead to, and how to recognize them within yourself. For our first blog in the series, we will focus on overconfidence bias and self attribution bias.
Overconfidence bias is the tendency for an individual to hold themselves at a higher intellect, talent, or skill set than what is objectively reasonable. Also known as when fake-it-’till-you-make-it never pans out.
We hear a lot about overconfidence bias in portfolio management. Simply put, investors may think they have more control and knowledge in their portfolios when in reality, it’s quite the opposite. This can lead to excessive risk in a portfolio, and ultimately reduce your investment performance. As you can imagine, this may also bleed into other areas of your financial plan.
Let’s start with questions to ask yourself:
Nobel Prize-winning economist and psychologist Daniel Kahneman popularized a “pre-mortem” simulation for investors to try. All you have to do is imagine your financial decision 5-10 years down the road. What does it look like if you succeeded, and what can you attribute to the success of your decision? Write that down. Now ask yourself what it looks like if you failed, and what can you attribute to the failure of your decision? Write that down. The purpose of this exercise is to bring to light the risks your overconfidence may be covering up.
Self attribution bias attributes success to one’s decisions, and failure to outside influences. Self attribution bias was heavily studied in 1975 by psychologists Dale Miller and Michael Ross. What they found is that when expectations were met, people tend to attribute internal factors. For example, your portfolio grew 16% in 2020 and you attribute it all to your investment selection capabilities... “look at how great of an investor I am!”. However, what Miller and Ross also pointed out was that when expectations are not met, people tend to attribute external factors. Let’s go back to the previous example. You find out the NASDAQ performed over 40% in 2020 (true story) and now attribute your lack of investment performance on bad information you fell victim to on the internet... “that blogger told me to diversify away from technology, this is all their fault!”
Self attribution bias can lead to individuals not learning from their mistakes or acknowledging their need for help. This makes sense, right? If it’s never your fault, there is nothing for you to improve upon or reflect over. Therefore, you may make the same error repeatedly until you can recognize the problem is indeed you, not them.
Questions to ask yourself:
Self attribution is surely present if your mistakes are blamed on others while your successes are credited to only yourself. When we take time to understand why an outcome truly occurred, we can then learn to repeat what works and eliminate our missteps.
Acknowledging our biases can improve our decision making. To think you are free of biases is a fallacy. As a financial expert, I am particularly susceptible to these biases, and therefore I pay attention when one flares up (spoiler alert: they never completely go away). I truly believe that because I have been able to recognize financial biases our financial foundation is stronger.
Upcoming Biases Blogs:
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Disclaimer: This article is for informational purposes only and is not a recommendation of Fyooz Financial Planning, Natalie Slagle CFP®, or Daniel Slagle CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment or financial planning strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.