On Thursday October 3rd, we did our Lucent annual investment seminar. As you know, we like to keep our events about life, fun and enjoying ourselves. But, there is some demand for something more serious and with a focus on the nuts and bolts of investing!
We had the pleasure of hosting Rebecca Kowalski from Overstory Finance discussing sustainable investing and Matt Hendy from Vanguard, who enlightened us on the quirks of human psychology and how it impacts our financial decisions.
Spoiler alert: we’re all a bit irrational when it comes to money!
We’re all a bit irrational, full stop!
Key Takeaway: Understanding our biases can help us make better financial decisions. Think of it as a mental tune-up for your wallet.
I am sure that made you feel a bit prickly! But it’s important to recognise that we are sometimes our own worst enemy. We understand that, and we do not blame or judge you for it. It’s normal! But, we all need a bit of help along the way, so let’s delve into this a bit more.
Meet Your Brain: The Star of the Show
Matt kicked things off by introducing us to the concept of Behavioural Finance. Imagine your brain as a two-speed bicycle:
System 1: Fast, instinctive, and emotional. Great for dodging lions, not so great for dodging market downturns.
System 2: Slow, deliberate, and logical. Perfect for those complex calculations, like figuring out if you can afford that extra avocado toast. Yes, you should definitely add bacon. But, this takes time and is tiring. Most of us are lazy!
Thinking Slow has helped humans do great things like travel to space and produce newsletters like this.
But, it wasn’t great for surviving on the prairie when we were evolving.
If, as that lion bounded towards you, you wondered whether it was a Barbary, Asiatic, Congo or Cape Lion, or even if it was a Sabre Tooth Tiger, Siberian Tiger or some kind of leopard… you’d be eaten! And not survive to pass on your genes. If you thought, “**** its got massive teeth” and pegged it, you might have survived! And so, those in built reactions remain in us all until today.
Fun Fact: Daniel Kahneman and Amos Tversky, the brains behind this theory, have written a book called Thinking, Fast and Slow. If you haven’t read it, Steve, and Karen’s boyfriend highly recommend it!
Why is this so important? It’s because it has an outsize effect on our investment returns
In Vanguard's paper “Putting a value on your value: Quantifying Advisor’s Alpha”, Vanguard found that Advisers can add up to 2% a year on to returns of their clients.
Biases: The Good, The Bad, and The Ugly
We all have biases, and they’re not always bad. They helped our ancestors survive to have the time to think slow (System 2). But in today’s world, they can lead us astray, especially in investing.
Types of Biases:
Cognitive Biases: Errors in memory, judgment, or logic. Think of them as your brain’s faulty wiring.
Emotional Biases: Driven by feelings like fear and greed. These are trickier to fix because they’re deeply personal.
Examples:
Ostrich Effect: Ignoring bad news in the hope it will go away. Spoiler: it doesn’t.
IKEA Effect: Valuing something more because you built it yourself. Yes, even that wobbly bookshelf.
Rhyme as Reason Effect: Believing something because it rhymes. “If the glove don’t fit, you must acquit.” Thanks, OJ Simpson’s lawyer!
Other than these three, there are lots of cognitive biases. 91 to be exact!
As we don't have time to cover all of these, below, we delve deeper into five main ones: Overconfidence, Anchoring, Loss Aversion, Confirmation Bias and finally, the Framing Effect.
Overconfidence: The Silent Portfolio Killer
Overconfidence is like that friend who thinks they’re a karaoke star after one too many drinks. It’s entertaining until it’s not. Obviously, this has never been seen at Lucent Staff parties where its more like the final rounds of X Factor. However, in investing, overconfidence can lead to risky decisions and, ultimately, losses.
Did You Know? For certain types of questions, answers that people rate as “99% certain” turn out to be wrong 40% of the time.
Anchoring: Don’t Get Stuck!
Anchoring is when you rely too heavily on the first piece of information you receive. For example, if you see a car priced at £20,000, you might think £18,000 is a bargain, even if it’s still overpriced.
Tip: Always look at the bigger picture and gather more information before making decisions.
Loss Aversion: The Fear Factor
Loss aversion is our tendency to prefer avoiding losses over acquiring equivalent gains. It’s why losing £10 feels worse than finding £10 feels good. This bias can make us overly cautious and lead to missed opportunities.
Here is an example from the stock market.
People fear losing 50% of the value of their money, and whether they can afford to do so. This WILL happen a few times a century, but, it will only be temporarily unless you sell out!
By selling out, they miss out on the following growth.
This is demonstrated in the illustration below, from Timeline, that shows length and depth of Bull (rising) and Bear (falling) markets.
Whilst you are worried about a temporary decline of 50%*
We are worried about you missing out on the next 508%!
*You need to have enough to be able to afford to take this risk so in the temporary declines, you are able to carry on life as normal.
Pro Tip: Stick to your financial plan, especially during market volatility. Your future self will thank you.
Confirmation Bias: The Echo Chamber
Confirmation bias is when we seek out information that confirms our existing beliefs and ignore anything that contradicts them. It’s like only listening to your favourite band and ignoring all other music.
Downsides:
Missing out on new opportunities.
Lack of diversification.
Falling victim to market bubbles.
Solution: Seek out diverse perspectives and challenge your assumptions.
Framing Effect: It’s All About Perspective
How information is presented can significantly impact our decisions. For example, would you rather pay £100 with a £20 discount or £120 with a £20 penalty? Most people prefer the former, even though the cost is the same.
Lesson: Be mindful of how information is framed and try to look at it from different angles.
Behavioural Coaching: Your Secret Weapon
At Lucent Financial Planning, we believe in the power of behavioural coaching. Our goal is to help you recognize and overcome your biases, so you can make better financial decisions.
What We Offer:
Empathy and Support: We’re here to listen and guide you through market ups and downs. What you are feeling is perfectly normal, but we need to ‘THINK SLOW’ using our system 2 thinking.
Long-term Focus: Keeping your eyes on the prize and avoiding short-term distractions.
Personalized Advice: Tailored strategies to meet your unique needs and goals.
“The adviser’s job is to help their clients avoid making costly mistakes.” John C. Bogle, the Late CEO of Vanguard
This is how we help: Case Studies and Real-life Examples
We are coming to the end of the newsletter now and I expect some of you are thinking “I would never be like that!”. If that is the case, you are not human! As we all do this. I do it.
If none of the behavioural biases we have demonstrated resonated, then there are over 80 others we have not gone into!
During the seminar, I looked around the hall and on every table I could see people that had displayed such biases. Some we had overcome entirely, or some we had just been able to mitigate.
Example: During the COVID-19 market downturn, many investors were tempted to sell their investments to avoid further losses. However, those who stayed the course and followed their long-term plan saw significant recovery and growth in their portfolios. It was a temporary decline.
At the time, I got on the phone and called every client that we knew had spare money in the bank.
Many of them invested.
The results from our whole client bank were:
£2million of extra money was invested in April to June 2020.
In ‘Power Factor 100’, our most invested-in 100% equity portfolio, we have seen a growth of 97.69% since 1st April 2020 (see graph below). The power of investing that money when people were most scared is massive! (not everyone invested in a 100% share portfolio, obviously, it’s just an example of making better decisions that we can help with).
One investor withdrew £20,000 (I talked down from £100,000 they wanted to). This was a mistake. But a small one compared to selling £100,000.
Many more clients increased the level of equity they held in their portfolios during this time.
This graph shows the power factor 100 portfolio performance.
All of this might have you thinking, what next?
Key Questions You May Have:
How can I recognize my own behavioural biases?
What strategies can I use to stay disciplined during market volatility?
How can I ensure that my financial decisions are aligned with my long-term goals?
All of these we can help you identify, and think about, so for when the time comes… You don’t react poorly. But! Even with the best preparation, having a calming voice by your side at the time can help you. We can relax you, show you some evidence, have you slow down and not make ‘thinking fast’ decisions.
Wrapping Up
We hope you enjoyed this deep dive into the world of behavioural finance. Remember, understanding your biases is the first step towards better financial health. If you have any questions or need personalised advice, don’t hesitate to reach out. We’re here to help!
Stay tuned for more insights and updates in our next newsletter.
Until then, have a happy life. That’s what it’s all about.
Your biggest behavioural bias may very well be that you think money is more important than ‘time’ or your life.
In the words of Paul Armson: You think you have time You don’t So stop fecking about Go see Lucent Financial Planning, so they can sort you out
He never said that last line, I just added it on 😉 he probably wouldn’t mind, since he awarded us with the inaugural ‘Inspiring Advisers Lifestyle Financial Planner of the Year Award.
This article does not constitute financial advice. We recommend that you speak to a qualified financial adviser for advice tailored to your individual circumstances and goals. Financial markets may go up or down, and you are not guaranteed a return on your investment. Past performance is not necessarily a guide to future performance.
About the author
Steve Rowe is the CEO and Founder of Lucent Financial Planning, an award-winning provider of financial services to individuals and business owners in the Midlands region. We want to be the Financial Advisers that change your life, not just the financial adviser that changes your ISA.
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