Behavioural biases: five tips to manage your investment bad habits

James Norton
7 August 2018
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So far in this series of articles, we have seen that behavioural biases are programmed into us. This is often beneficial as it helps protect us against potential dangers, or helps us fix problems. But such biases are not so useful when it comes to investing.

Whether it comes down to being over-confident, paying too much attention to the recent past or finding facts to confirm what we already think, biases can be dangerous for our wealth.

Therefore good investing behaviour is essential. Here are a few pointers to consider:

1. Be aware of your biases - knowing that you have biases is a great starting point. After all, you can’t fix what you don’t know. This sounds simple, but it can be harder to put into practice. For example, if you suffer from the overconfidence bias, ironically, the more overconfident you are, the less likely you are to notice it. If you’re serious about it and are prepared for the feedback, ask a friend or colleague about some of your strengths and weaknesses. It may be enlightening.

2. Remember your goals - remind yourself why you’re investing. For many, the aim will be achieving a comfortable retirement. So, framing your investments with these long-term goals helps keep you on track. The next time you are thinking of selling some investments or stopping your monthly savings plan as you want to spend your money on something else, remember why you started investing. It’s about patience, not short-term gains.

3. Document your decisions - managing behavioural biases is about overcoming emotional reactions to situations. So it can be a good strategy to document your decisions. When you have decided how you want to invest and your reason for selecting certain funds, write it down. Consider writing down your goals as well.

When you next want to change the portfolio, check your notes and remind yourself of your original thinking. It will help you learn from mistakes and hopefully prevent you taking unnecessary action. Just like good advisers will have an investment philosophy, so should you.

4. Have a process - if you have a good process, it helps remove the emotion from investing. Decide how often you are going to review your portfolio. It doesn’t have to be daily - monthly or even annually will do for most investors. Also, decide how often you are going to rebalance your portfolio. Will it be annually or based on how much holdings have moved? It probably doesn’t matter which method you choose, but when you have one, stick to it. This way you don’t have to make judgement decisions on when to buy and sell holdings.

If that feels like too much work, some funds will do the rebalancing for you. These funds keep the asset allocation constant through a disciplined rebalancing process so you can maintain the right level of risk.

5. If in doubt, get an adviser - many investors don’t have the time, willingness or ability to manage their own investments and that’s fine. If that’s the case, find a well-qualified adviser who can act as your coach and make these decisions. But when selecting an adviser it makes sense to check they have good processes and that their own biases are not too strong.

Finally, remember, investing does not have to be complicated or time consuming. Buying a couple of low cost, well diversified funds and using your tax allowances where appropriate, will be the right solution for most of us. Then you just need to sit back and let the investments take care of themselves, checking them on an occasional basis. The next time you want to trade, just ask yourself; “do I really know better than the market?”. If the answer is no, which surely it should be for most of us, the best course of action is probably no action.

James Norton is a senior investment planner at investment firm Vanguard UK.