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In a growing sea of info, your biases can sink you
TODAY, we live in a world of exponential information growth.
This trend is revolutionising the field of investing, where big data and powerful analytics can provide invaluable insights for professional fund managers.
With the rapid democratisation of information, even individual investors today can access large amounts of market intelligence, such as daily news flow, data feeds, analyst reports and others.
From my years of experience with high-net worth clients, however, I've found that this phenomenon can be a double-edged sword.
Because some individual investors are less self-aware of the effects of the behavioural biases inherent in our nature, a growing abundance of information can sometimes exacerbate poor decisions.
Let me give an example.
One critical pillar of a sound investment strategy is portfolio diversification.
For some investors who are over-concentrated to certain assets or single stocks, their poor decisions may have been exacerbated by "the confirmation bias".
A hypothetical investor who is over-exposed to a single stock of an apparel company may experience something like this: After buying a large number of shares, he immediately begins to notice glowing news articles, positive analyst recommendations, and even many on social media wearing the company's products.
He then reinforces his initial belief that the company is indeed on a positive financial trajectory, and that his portfolio is soundly positioned.
This is a classic case of the confirmation bias in action. That is, after taking an initial position on an issue, we suffer a tendency towards noticing things that confirms and strengthens our favoured view.
The reality in this instance could well be that the number of positive articles, analyst recommendations or customers did not increase over this period; it is only that the investor's perception has changed due to the influence of the confirmation bias.
Of course, it is easy to see how an over-abundance of information can provide ample fodder for those who do not actively keep their confirmation biases in check.
In an information-rich world, the confirmation bias often works hand in hand with another behavioural flaw - the anchoring bias.
The anchoring bias describes our tendency to root decisions in an initial belief, frequently because it is intuitive or widespread in popular media, and then to use it as a reference point for future decisions, even if it has little objective basis.
Anchoring often occurs when investors do not know the subject matter well enough.
One example is that some investors like to buy stocks which have experienced sharp price declines.
The reality is that some of these stocks would have declined due to irreversible changes in their business fundamentals - and therefore have little or no likelihood of returning to previous highs.
These investors, however, are "anchored" to previous financial performances and price levels, and wrongly believe that they are buying these stocks at discounted prices.
Due to the dual impact of the confirmation and anchoring biases, it is not uncommon for me to encounter clients who are strongly attached to unsound investment beliefs or decisions.
It may come as a surprise that - despite being presented with objective analyses or reasoning - it can be an uphill task for some clients to change their minds.
Why is that?
This brings me to the last behavioural flaw that I will discuss today, which is "the over-confidence bias".
It is established in the field of psychology that humans are generally over-confident about their abilities and knowledge.
One way to see this is in the well-documented "Superiority Illusion" phenomenon, which describes that the vast majority of us believe we are above average in any measurement of competency, although mathematical reality dictates that only half of us can be.
In my experience, unfortunately, the over-confidence bias is certainly prevalent in the area of investing.
For instance, many of us are over-confident that we can outperform by managing our own investment portfolios, instead of leaving this to professionals with sound track records. Many of us also believe our portfolios are diversified enough when they actually are not. Both of these observations are well corroborated by studies in economic literature.
For investors to achieve sound performance over the long term, particularly in this age of growing information, I believe it is ever more important for us to be cognisant of our inherent behavioural flaws, and actively put them in check.
From my decades of client interactions, what I've found is that while the majority of individual investors intellectually appreciate the negative influences of these behavioural biases, the decision to put these flawed instincts in check is not easy for some to make.
Yet, a few simple steps can be taken to nullify them, such as exercising objective and rational judgment, double-checking your conclusions, practising effective diversification, and also delegating management to capable professionals.
After all, most of us would not hesitate to seek professional medical help when it comes to our physical health. Would it make sense to take a DIY approach when it comes to our financial well-being?
- The writer is the global head of Products at the Bank of Singapore