Participants Display a Variety of Risk Biases, Damaging Outcomes

Findings from a recent investor survey conducted by SEI in collaboration with Phoenix Marketing International show there are many different biases impacting the behavior of retirement investors.

According to John Anderson and J. Womack, both managing directors with SEI, the act of pursuing and maintaining risk exposure runs against investors’ natural instinct to try to prevent losing money. However, these same protective instincts can undermine their ability to achieve specific longer-term goals.

“The need for effective coaching is apparent given the results individual investors produce,” the pair suggest in a white paper summarizing the survey findings.

Anderson and Womack observe that U.S. investors timed their sales and purchases of diversified mutual funds poorly over the past 10 years, from 2008 through 2018—a period that experienced the great financial crisis and significant market selloffs, as well as calm and rising markets. They point to the following biases as big drivers of sum-optimal investment decisionmaking:

• Availability bias, which is a bias causing investors to judge the likelihood of future outcomes according to past experiences of similar outcomes.
• Belief perseverance bias, explained as a bias causing people to be unlikely to change their opinions even when new information becomes available.
• Confirmation bias, through which people seek out confirmatory beliefs, overlooking beliefs that don’t confirm their views.
• Herding bias, which is the idea that people feel most comfortable following the crowd; they tend to assume that the consensus view is the correct one despite rational evidence indicating otherwise.
• Hindsight bias, through which people believe they had predicted a particular outcome when in fact they had not.
• Loss aversion bias, which describes the cognitive bias that the pain of losing is more acute than the pleasure of gain.
• Overconfidence bias, occurring when confidence in one’s own judgment is greater than the objective accuracy of that judgment.
• Overreaction bias, which suggests that people are overly influenced by random occurrences and tend to over-interpret patterns that are coincidental and unlikely to persist.
• Recency bias, or the tendency to believe that what occurred in the past will continue to occur in the future.
• Regret avoidance bias, or the tendency to avoid actions that could create discomfort over prior decisions.

Investors tend to display some or all of these biases in different proportions, according to Anderson and Womack.

“The likelihood of making judgment errors increases if we neglect the impact that biases have on our own thinking,” they explain. “While many behavioral biases are unconscious, being mindful that we’re all subject to them is a good place to start to help avoid them.”

The paper recommends that investors check their egos and develop disciplined, repeatable processes that can minimize short-cut thinking. Investors are also encouraged to make a habit of considering other possibilities and to reframe errors as opportunities to learn and grow, rather than as evidence of incompetency.