10 Mind Tricks That Are Keeping Your Clients In The Red<br><br>
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Be aware of these factors to help you avoid some psychological pitfalls that regularly affect professional and amateur investors alike.
Source: Robert W. Baird & Co.’s Private Wealth Management Research
1. The mind anchors where it shouldnt.<br><br>
Tips and Advice:
Watch out for anchoring your judgments on a price or valuation that may be irrelevant like past performance or 52-week highs/lows. Use multiple benchmarks or reference points to better triangulate. Try to understand why something is priced the way it is there is usually a good reason. Realize that the margin of error in any decision is often larger than you anticipate.
2. The mind wants to be right and avoid being wrong.<br><br>
Tips and Advice:
Dont get attached to a particular investment opportunity. Employ objective screens when selecting investments. Play devils advocate with yourself. Ask disconfirming questions. Use trusted external resources as sounding boards.
3. The mind prioritizes information thats prominently available.<br><br>
Most people weigh the neighbors claims more heavily despite it being a sample size of only one because it represents a more salient example.
Tips and Advice:
To train yourself away from this availability bias, keep accurate records of why an important financial decision was made and refer to it to help prevent future mistakes. Dont let abnormal, one-off events dictate your strategy.
4. The mind can see 20/20 in hindsight.<br><br>
Tips and Advice:
Remain focused on the long-term and dont let daily market volatility or events drive emotions.
5. The mind loves to play mental accounting games.<br><br>
Tips and Advice:
Take a holistic view rather than arbitrarily segmenting your assets. Create a financial plan that includes all your assets. Focus on both sides of your personal balance sheet when making decisions.
6. The mind fears losing more than it values winning.<br><br>
Heres where emotion can really turn logic on its head. Prospect Theory shows that when posed with expected gains, people are risk-averse but when posed with expected losses, people actually become risk-seeking because they hope to avoid a big loss. This psychological tendency makes it very difficult for financial advisers to help clients steer a steady course in the face of market losses!
Tips and Advice:
To combat loss-avoiding emotions, try to spread out a gain as opposed to realizing the entire amount immediately. When faced with potential losses, sometimes it is easier to take one large loss and move on than to prolong it into a series of smaller losses. Dont become overly aggressive when trying to make up for market losses!
7. The mind wants to recognize positives immediately and defer negatives until later.<br><br>
Tips and Advice:
To avoid cutting short great investments and holding hope for poor ones, use set criteria for purchasing or selling securities. Incorporate new information as it comes available. Employ formal or informal stop loss limits. And, remember Warren Buffets counsel: The most important thing to do when you find yourself in a hole is to stop digging.
8. The mind is prone to overconfidence.<br><br>
Tips and Advice:
Be aware of areas youre skilled in and those where you arent. Allow third-part experts to invest on your behalf in areas where you dont have expertise. Be honest when attributing success and failure and set realistic expectations.
9. The mind expects reversion to the mean even when odds are steady.<br><br>
In investing, the parallel concept is expecting reversion to the mean. People often assume that outperforming or underperforming securities will somehow revert back to average (the mean) over time. Sometimes this happensbut sometimes not! Some investments are simply really good or really bad.
Tips and Advice:
Try to separate chance from skill. In situations of chance, know that previous outcomes should have little bearing on your decisions. When viewing past performance, try to understand the drivers of those returns and whether outperformance can continue or underperformance will correct itself.
10. The mind tends to follow the herd.<br><br>
Its one thing to fall victim to a fashion faux pas when conforming to social pressures. Its quite another thing to put your wealth at risk because of the actions of others.
Tips and Advice:
Make decisions based on what is most suitable for your investment style and financial situation. Think like a contrarian by asking what everyone is missing instead of fearing that you are missing out. Do your own homework or engage a third-party expert to investigate ideas on your behalf.