– Benjamin Graham
Much of traditional economic and financial theory is based on the assumptions that individuals act rationally and consider all available information in the decision-making process.
However, behavioural finance research has revealed that often, investors do not behave as rationally. Most famously, Kahneman and Tversky in 1979 published “Prospect Theory: An Analysis of Decision Under Risk”. Using cognitive psychology, they explained various divergences from rational investment behaviour.
When investing, investors often go through a roller coaster of emotions that can be difficult to keep in check. The following diagram is an illustration of what some people go through when investing.
While our biases may serve us on a day-to-day basis, for example by helping us avoid potentially dangerous situations, with investing, they can have the opposite effect.
By understanding behavioural biases, you may be able to moderate these biases or adapt to the bias so that investment decisions more closely match the rational financial decisions assumed by traditional finance.
Overconfidence is a bias in which people demonstrate unwarranted faith in their own intuitive reasoning, judgments, and/or cognitive abilities.
Overconfidence may be intensified when combined with self-attribution. Self-attribution bias is a bias in which people take credit for successes and assign responsibility for failures. In other words, success is attributed to the individual’s skill, while failures are attributed to external factors.
In a 1999 study, Barber and Odean analysed the trading behaviour and psychology of 78,000 U.S. household investors. They found investor overconfidence and self-attribution to be important motivations for excessive trading.
Excessive trading can, in turn, lead to you incurring more fees than necessary without having the performance to match.
Instead of trading excessively and incurring fees, Crea8 monitors your investment portfolios and strategies and only trades/suggests trading when the portfolio has drifted beyond a certain percentage away from the optimised portfolio that you initially set up. We let you determine the drift margin and whether your portfolio is rebalanced automatically or manually.
Availability bias is an information-processing bias in which people take a rule of thumb to estimate the probability of an outcome based on how easily the outcome comes to mind.
With confirmation bias, people tend to look for and notice what confirms their beliefs and ignore information that does not support their beliefs.
If unchecked, confirmation bias and availability bias can lead to you narrowing your investment opportunity set and not considering all available information before deciding. This, in turn, could lead to the creation of sub-par investment portfolios.
Crea8 can help you overcome. Through our Goal based investing service, we make available up to 350 ETFs, while our Factor based investing service offers you up to 2,500 stocks from 18 different countries. This ensures that your investment opportunity set is wide.
Further, with Crea8 Analytics we give you the professional tools to let you filter out stocks based on fundamental data and alternative data such as analyst’s forecasts.
Hence, with Crea8, you get access to not just a wide investment opportunity set, but also a wide array of information pertaining to listed securities to ensure your decisions are optimal.
Conservatism bias is a belief perseverance bias in which people maintain their prior views or forecasts by inadequately incorporating new information.
Loss-aversion bias is a bias in which people tend to strongly prefer avoiding losses as opposed to achieving gains.
Conservatism and loss aversion can lead you to hesitate to realise your losses and hold stocks for too long hoping for a recovery. This is known as the “disposition effect” which is the tendency of investors to sell winning positions and hold onto losing positions.
With Crea8’s smart monitoring tools, you can avoid this disposition effect by specifying a limit on maximum possible loss, without setting a limit on the possible gain. Your stop-loss limit will move with the market price and continually recalculates the stop trigger price at a fixed amount below the market price.
As the market price rises, both the stop loss limit price and the stop trigger price rise will be adjusted upwards. But if the stock price falls and hits the trigger price, then your stop-loss order is submitted at the last calculated limit price.
Your psychological biases can hinder your investment decisions and limit your ability to grow your wealth and beat the market.
With Crea8’s wide array of investments, smart portfolio monitoring features and professional stock selection tools, we help the effect your psychological biases have on your investment decisions.
Kahneman, Daniel, and Amos Tversky. 1979. “Prospect Theory: An Analysis Of Decision Under Risk”. Econometrica 47 (2): 263. doi:10.2307/1914185.
Barber, Brad M., and Terrance Odean. 1999. “The Courage Of Misguided Convictions”. Financial Analysts Journal 55 (6): 41-55. doi:10.2469/faj.v55.n6.2313.
