When it comes to making money with investments, cognitive biases can really hurt performance. And clients have plenty of biases to go around, says Tea Nicola, CEO of Vancouver-based WealthBar Financial Services Inc..
“At times like these, when markets are volatile, it really changes how you think,” Nicola explains in a release. “Emotions creep in. For instance, a bias of loss aversion can make you want to cash out. And if you’ve been invested for a while, this can cause you to lose money.”
Psychological traps can really hurt returns over time, Nicola says. “For most people who were invested for the long term, with a 10-year or more time horizon, it would have been better to just stay invested. Eventually, we’ll see a recovery from the sluggish market we’ve seen lately.”
Nicola outlines the most common cognitive biases that can affect investors’ performance:
> Recency bias
Past performance is no guarantee of future returns … and yet, many investors act as though it is, Over time, as an asset rises in value, we can expect it to fall back down to the mean.
> Confusing the familiar with the safe
Blockbuster, Nortel, Sears, Pan Am Airlines, Pets.com … they all seemed like big, safe companies to invest in at one time. But size and great branding is no guarantee of safety. From the original Fortune 500 list, relatively few even exist today.
> Running with the herd
You want to be fearful when others are greedy and greedy when others are fearful, says Nicola. By the time you put a client’s money into it, most of the gains may have been realized and it might even be headed for a fall.
> Focusing on returns while ignoring the fees
A 2.2% average fee for a mutual fund can really dig into long-term average returns — particularly when there are options out there that could be a third of that fee.
With the RRSP investing deadline coming up on March 1, are cognitive biases keeping many nervous clients on the sidelines, away from getting tax-deferred retirement savings? That could be the case, Nicola says.
“It can make them hesitate, or make knee-jerk reactions that are hurting them in the long run. But with a long term focus and a strategy of diversification, many Canadians can enjoy better returns even when they’re investing during volatile market conditions.”