Taming Financial Biases
Every year DALBAR, an independent researcher for the financial community, releases its report on what returns the “average” investor earns versus the S&P 500 stock index. This year it reported that over a 20-year period, the average investor earned 5.96% while the S&P 500 earned 7.47%. That’s a difference of 1.51%, which doesn’t sound like much until you do the math over 20 years. The average investor’s $100,000 investment in that time will have earned 25% less — that’s $104,118 — than what the S&P 500 returned.
Why? Because the average investor has a tendency to buy high and sell low. That investor’s judgment is swayed by at least three factors: loss aversion bias, confirmation bias, and recency bias. Here’s what they are and how to tame them:
● Loss aversion bias: The pain of losing is psychologically twice as powerful as the pleasure of gaining. Instead of potential gain, we focus on the risk of loss. So when average investors see a dip in the market, they freak out and sell. Antidotes: Gratitude, thinking long-term, and being realistic and honest about the likelihood of catastrophic outcomes.
People hire financial planners like me precisely because they want to keep their emotions out of investing, or they want support amid all of the bad news, downturns and scary projections. They want to know how to reach their life goals and make their money support those goals. If you would like help with your planning and investing — or reducing your biases in life or finance — please reach out.