Financial bias: How caution could be affecting your future
Posted onResearch has highlighted how being cautious with pension investment can be as damaging as taking too much risk. In some cases, a cautious approach is appropriate. But, in others, it’ll be the result of subconscious financial bias affecting the decisions we make.
Research from Cass Business School found women are more risk-averse than men. It’s a trend that could be affecting how much women have in their pensions and other investments. The research also found that young people and those that are single are more likely to be risk-averse too.
Professor David Black, co-author of the paper and Director of the Pensions Institute at Cass, said: “Women, because they are more risk-averse than men, would be more comfortable with lower-risk investments. Over a long investment horizon, such as that involved in building up a pension pot, this behaviour has been described as ‘reckless conservatism’ – women with the same salary history as men would, on average, have lower pensions as a result.
“On the other hand, men’s investment overconfidence can lead to ‘reckless adventurism’. This is not necessarily desirable at older ages close to retirement, since there is less time to recover from a severe fall in stock markets.”
What is financial bias?
Financial bias is simply a human tendency that affects our behaviour and perspective. These may be based on beliefs and experiences. In financial terms, bias may affect your ability to make decisions objectively. For instance, you may make a choice based on emotional bias rather than evidence.
Taking the above example; why are women more likely to take less risk with investments? It’s likely that bias is having an impact. Whilst the research didn’t show their personal circumstances, pre-conceived ideas will be affecting some women when they decide how much risk to take.
There are many forms of financial bias that may affect your decisions, including these three:
1. Loss aversion
This is the financial bias that the above research looked at. It’s an emotional tendency to prefer avoiding losses over making gains. Past research has indicated that the pain of losses is greater. As a result, investors may choose lower-risk options than appropriate to avoid this.
Another example of loss aversion is selling stocks to prevent further losses before you planned. Whilst doing so may protect you from further falls, it can be damaging. Selling stocks and shares effectively lock in your losses. Remember, over the long term, investments typically deliver returns.
2. Confirmation bias
Let’s say you’re looking at pension opportunities and decide one option is too high risk. But you decide to do some research anyway. Confirmation bias leads you to seek out information that supports your view. So, you’d discard the figures that suggest it could actually suit you. As a result, research simply backs up what you already believe.
Confirmation bias can lead to a one-sided financial view. It can make it difficult to objectively balance the pros and cons. Being aware of this can go some way to improving your research process, as can working with a financial planner.
3. Herd behaviour
If you’ve ever found your action mimicking those of a larger group, herd behaviour could be to blame. In some instances, it’s right to follow what others are doing. But it should align with your own reasoning, plans and wider goals. With so much noise in investment markets, it can be difficult to focus on what’s right for you.
For example, if markets start to decline, you may pull out investments if others are doing so. This is because you believe that the majority must be right. Yet, their circumstances and aspirations may be very different from yours. It’s important to build a financial plan you have the confidence to stick to.
How can financial planning help?
Working with a financial planner can help you remove some of the bias from decisions. It allows you to view your options through another’s eyes. You may have a clear idea about the best way to invest for retirement, for example. But after talking with a financial planner, you discover that taking more or less risk is appropriate.
Financial bias can also mean making snap decisions. For instance, when the value of stocks begins to fall you may consider selling. Having a long-term financial plan in place can give you the confidence to hold steady. This, in turn, can help keep you on track for your goals.
If you’d like to discuss your financial future, please get in touch. Our goal is to create a financial plan that reflects you and that you have confidence in.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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