Market Minute - October 13, 2017
by Scott Rosenquist, CFA
The behavioral aspect of finance and its potential impact on investors reaching their financial goals is an important topic to be aware of. I’d like to spend another minute to discuss additional biases from the two categories (Cognitive and Behavioral) I introduced in my last post.
I think these two may be particularly timely given the current market environment.
Familiarity Bias: A cognitive bias when investors tend to stick to investments they are familiar with, giving them a level of comfort. Investors may hold assets only in their home country given their lack of familiarity or available information on global investments. Employees may also own a high percentage of their company’s stock in their 401(k) plan compared to investments outside their level of comfort. This bias can lead to a potentially under-diversified portfolio that may not fit an investor’s risk/return profile.
To mitigate this bias, an investor should consider these steps: Take a global perspective for asset allocation; assess the risks and limits associated with their concentrated position; identify if there are opportunities to increase diversification. These steps will help you broaden your perspective and can distance you from a bias that may not be providing you the benefit you think.
Status Quo Bias: An emotional bias where investors prefer to keep things the same instead of making a change. Investors may put off decision making for several reasons such as the decisions are too difficult or complex, the work needed to enact a change, or possible regret from making a wrong decision in the past. This can lead to investors having a portfolio that no longer fits their risk/return profile. The investment industry created target date funds that change their allocation as the predetermine date approaches as a means to address this bias.
Another option is for an investor to engage in a regularly scheduled review of their portfolio allocation with their Relationship Manager for potential diversification benefits.
The familiarity and status quo biases are related in that investors may seek comfort by holding what is well known and has worked in the past, and forego decision making due to lack of information or the time it may take to fully understand and enact all their investment options. Given the strong performance of the U.S. markets, many investors may delay rebalancing or actively seeking other opportunities and strategies. Investors should review their allocation periodically to make sure it still fits their risk profile as well as be open to discuss with their Relationship Manager how their biases may be impacting their portfolios and ultimately, their goals.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to nor does it represent or reflect transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.