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We’ve all taken personality tests either online, at work or school, and we know that who we are determines how we interact with our world. Who we are also impacts how we handle our money, particularly our investments. Our life, experiences, and personality can create biases.
Will Stone, CERTIFIED FINANCIAL PLANNER™ at McMullin Stone & Associates of Fayetteville, identifies four specific behavioral financial biases that can affect our savings and investment strategy.
1. Overconfidence
“That is pretty much what it sounds like, where we have higher confidence in our abilities or higher confidence in a certain outcome based on our perspective, than is actually warranted,” Stone says. “When we have invested money and it’s done well, we tend to think it’s going to continue to do well and that’s not always the case.”
Stone says that clients who’ve been very successful in life or in their careers, and assume that success translates into all areas, are sometimes victims of overconfidence bias.
“There can be certain gotchas from a financial standpoint, like in the area of taxes or estate planning, that might trip somebody up if you’re not open to someone else’s expertise.”
2. Familiarity
“We tend to gravitate towards what we know,” Stone explains. “Do you always go to the same restaurants? Do you always order the same things on the menu? If you always gravitate towards the same thing, that may indicate that you have a Familiarity Bias.”
While there’s certainly nothing wrong about eating frequently at a favorite restaurant, familiarity bias doesn’t always produce the best investment strategy.
“I’m a big fan of making investment decisions based on things that make sense,” Stone continues. “I like for clients to make decisions about investments that they understand. If we have an investment idea or a planning strategy that we feel would be a good fit for a particular client, but it’s unfamiliar to them, then we spend some time talking them through it. We help them understand how it works, and how that may benefit them financially.
3. Loss Aversion
“With Loss Aversion Bias people are more concerned with not losing money than actually making money,” Stone says. “We see this often when we get into a rough cycle in the stock market.”
For example, Stone explains, when we walk into a store and see signs that a big clearance sale is going on we get excited and start making cheap purchases.
“But when the stock market goes down and things are on sale, most people are pretty fearful. They’re more worried about losing money than they are about the opportunity to actually invest and make money. That’s a key sign of having a bias towards loss aversion.”
To help clients overcome that bias, Stone says it’s always important to understand what the investment “horizon” is — whether they’re looking for quick returns or steady returns over a longer period of time.
“If they have a shorter time horizon then we will stay away from investments that are going to be more volatile and likely to trigger those biases towards loss aversion,” Stone says. “We also try and reinforce the fact that there will be market corrections. There will be times when their accounts go down in value and the reason that they can be okay with that is because they’re planning on having that money invested for a long period of time.”
4. Mental Accounting
“This is the way in which we account for the same thing differently based on where it came from or what it’s for, and this happens a lot with money,” Stone says. “Clients look at money differently depending on whether it’s part of their salary, whether it was a bonus, whether somebody gave them a gift, or whether they inherited it from a family member. In the end, it’s all just money.”
Stone says he sees this bias most often with money that’s inherited, because it comes with a certain emotional attachment.
“Clients may be averse to losing those funds because, ‘My dad worked hard for it and it represents the work he did over his life’,” Stone explains.
It’s possible for clients to have multiple biases, Stone admits.
That’s why it’s important to have unbiased financial planners take a look at your investment strategy, to view it through a different lens.
To learn more about financial biases and how you can overcome them in your own investment strategy, or to learn about the services offered through McMullin Stone & Associates, email Stone directly at [email protected] or call 770-471-6674.
McMullin Stone & Associates is located at 101 Devant Street, Ste 903 Fayetteville GA 30214. Securities offered through Raymond James Financial Services, Inc. member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. McMullin Stone & Associates is not a registered broker/dealer and is independent of Raymond James Financial Services.
Join McMullin Stone & Associates at a special
Wisdom of Women: Your Personality and Financial Biases
Explore personality profiles through the Enneagram with special guest speaker Logynn Ferrall AND hear more insight on Financial Biases with Will Stone, CFP®.
Tuesday, March 3, 2020
11:30 a.m.-1:30 p.m.
Includes Lunch
The Loft at Due South
Advanced, complimentary registration is required by February 18 to [email protected]
Raymond James is not affiliated with and does not endorse the opinions or services of Logynn Ferrall or Enneagram.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James.
Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.
