Financial Post: Biases may be impacting your financial outcomes. Here’s how to fend them off.

Humans inherently have biases, but many don’t realize financial biases exist. Emotions naturally play a role in our financial success, leading us to safeguard against their impact through measures such as maintaining multiple bank accounts and diversifying our investments.

Ironically, what may seem like appropriate reactive strategies might be biased thinking. This is why it’s important to bring in a financial adviser with the expertise to recognize and coach investors through these biases.

Swings in financial markets can breed fear and cause even rational investors to make irrational decisions. Bouts of market volatility are normal, and the correct solution isn’t to withdraw or try to time the markets. Based on the S&P/TSX composite index over a 20-year timeframe (2002 to 2022), missing just the 10 best days in that investment period would have resulted in only 54 per cent of the returns (4.6 per cent versus 8.5 per cent for the full period), according to SEI Investments Co. and FactSet Research Systems Inc.

Instead of pulling your investments out during times of stress, seeking professional advice can help you navigate your financial biases. The biases advisers most frequently encounter among clients include sensitivity to losses, recency bias to the latest market moves and tendencies to invest in things that are familiar.

Financial bias trio

Have you encountered an investment that didn’t meet your expectations? Perhaps you invested $400 in a stock, only to witness its value plummet to $200. Such setbacks can have a lasting impact, making it natural for hackles to be raised when considering future opportunities.

This tendency is frequently recognized as loss-aversion bias, through which our reactions to losses are stronger than our responses to similarly sized gains. Recent data shows that a majority of advisers see loss aversion as the most prevalent bias among clients.

Investors with loss-aversion bias may try to take a heavy hand in their investments and can be susceptible to making overly conservative investment decisions that don’t necessarily match their risk profiles or investment goals. This unwillingness to accept losses or take risks will ultimately impact long-term returns.

Investors with loss-aversion biases should try to avoid checking on their investments frequently or moving investments around when things go down. A hyperfocus on day-to-day portfolio valuations, especially during times of volatility, will only distract you from your long-term goals.

Similar to loss-aversion bias, recency bias can also lead investors to make impulsive and reactionary decisions. Recency bias is the mentality in which investment decisions are made based on recent market events instead of looking broader and big picture.

For example, you may be seeing headlines about a particular sector that is booming, but that doesn’t mean you should rework your entire portfolio accordingly. Yet 50 per cent of financial advisers see this behavioural tendency within their clients and view it as the second-most-prevalent financial bias.

Diversification is key to helping combat recency bias and avoid going all in or all out on specific sectors or asset classes. Awareness of this bias promotes a more balanced investment approach, weighing both short-term fluctuations and long-term objectives.

Amid recent market volatility, an investor will often find comfort in investments that have performed well within their own portfolio in the past. This third type of financial bias is called familiarity bias, the predisposition to invest in assets that are familiar.

Familiar investments may provide a sense of security, but the most secure portfolio is one that is diversified. One in four financial advisers cite this as a common bias among investors, which can result in an under-diversified portfolio that can limit clients from achieving their goals.

Every minute, we are bombarded with a staggering 11 million pieces of information, though our conscious mind can only handle around 40 pieces at once, leaving more than 99.9 per cent of the incoming data to be processed unconsciously, according to Timothy Wilson’s book Strangers to Ourselves: Discovering the Adaptive Unconscious.

Grappling with financial decisions often involves emotions tangled with personal history and anxieties, but you don’t have to tackle these choices by yourself. A financial adviser can address and safeguard against biases through collaborative goal-setting strategies that make you feel comfortable, so you don’t change course when volatility hits.

A goals-based wealth management approach centres on understanding how you want your finances to serve your life’s purposes. This approach reduces risk and anxiety and combats bias-influenced decision-making by diversifying assets. A great plan also includes consideration of charitable giving and intergenerational wealth transfer, ensuring support today or tomorrow, as well as later life stages.

Dedicating time to understanding your personal biases and their influence on financial decisions can help steer you to better financial outcomes. Collaboratively addressing these biases through goals-based wealth management can provide the freedom to step back and confidence that your adviser’s got your financial objectives covered no matter what’s happening on Wall Street.