How to identify and build your investor identity
There’s lots of evidence to suggest that most of us have innate irrational biases that lead to poor decision-making. Worse still, in times of crisis the reasoning part of our brain actually shuts down a bit, increasing our likelihood of making poor decisions.
“There is nothing more emotional and irrational than the relationship people have with their money,” Frank Murtha, head of Market Psych, told a group of advisors last week in Toronto.
Fear and greed, always at odds, are the two strongest emotions at play in investing, says Murtha whose firm often works with advisors to help them incorporate investor psychology concepts into their businesses.
“Fear crushes greed; it’s not a fair fight because the pain of loss and its emotional imprint is two-and-a-half times greater than the joy of any gain,” Murtha explains.
In other words, although most of us may not want to take a chance on getting rich, we tend to take chances to avoid becoming poor. Say you just received a $1,000 fine for a traffic infraction and faced with two choices. Pay the fine outright or enter an amnesty lottery where you have a 50% chance of having it waived or a 50% chance of seeing it doubled to $2,000.
Nobel Prize winner Daniel Kahneman showed that most people would tend to enter the lottery to avoid paying the fine. Would you do the same?
Probably, even discerning investors can find it difficult to moderate their emotional and cognitive biases when it comes to investing. Which is we look at advisors as behavioural investment coaches who set up processes that may help enable us to overcome such biases.
Some advisors believe that the financial world’s rush to embrace behavioural finance may be a little too much too soon, however.
“Behavioural finance is a wonderful science and tool, and when used correctly, provides a great opportunity to further the relationship between clients’ emotions and their money and saving goals,” says advisor Chip Workman.
But, for advisors, using these insights properly also means having to confront some painful truths about themselves, he adds.
Are you in synch with your advisor on these issues? Do you feel that he or she is able to protect you from giving into your emotions?
By Gordon Powers, MSN Money
* Follow Gordon on Twitter here.
Posted by: rob | May 4, 2021 8:16:27 AM
You forgot the other half and the most important aspect of the Kahneman study that you were quoting...that if presented with two options:
a) to either take $500 as a gift or gamble 50/50 to win 0 or $1000, most people chose the safe play or
b) to either pay $500 or take a 50/50 chance to pay 0 or pay $1000, the same people tend to choose to gamble to prevent the loss even though these scenarios are identical in terms of payout.
The point being that we are asymmetrical with our behaviour regarding risk: risk seeking to avoid losses, and risk averse to hang onto gains.