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The 2010 Behavior Survey: Biases of Aggressive Investors

More results from our attempt to connect real people with behavioral finance theory.

Michael M. Pompian, 10/21/2010

This article is the fifth in a series examining the results of a practical application of behavioral finance survey that I recently did in partnership with MorningstarAdvisor.com (more details on the survey can be found in the original article).

By now your should know that the population of survey takers in the Morningstar universe can be generally defined as "mostly male, mostly experienced (experienced having a double meaning here--experienced in the sense that they are not new to investing and experienced in the sense that that over half of the survey takers were older than 60), and mostly do-it-yourself" investors. What this means is that the majority of survey takers were very proactive, engaged and self-directed investors which, naturally, is only a subset of all investors. For simplicity, I will call the investors who took the survey "PEM investors" going forward to stand for proactive, experienced and male investors. We will study today how survey-takers answered questions related to biases of growth-oriented-investors and I will offer some commentary about this data.

Biases of Aggressive Investors
Overconfidence Bias
Bias Type: Emotional
Bias Description: Overconfidence is best described as unwarranted faith in one's own thoughts and abilities. Overconfidence manifests itself in investors' overestimation of the quality of their judgment. Many aggressive investors claim an above-average aptitude for selecting investments; however numerous studies have shown this to be a fallacy. Below is the survey question related to overconfidence bias.
 (View the related graphic here.)
Commentary: Given the population of investors answering this question, this result of approximately 60%/40% is expected. Many investors have seen the benefits of sticking to a long-term plan. For example, the March 2009 lows were quickly erased in a very short time. Those who stuck with their plan saw their portfolios bounce back nicely. The flip side is that 40% of PEM investors said they like to change with market conditions. Advisors need to be aware of situations that clients may change their portfolios only to see the opposite of what they had intended to do occur.

Self-Control Bias
Bias Type: Emotional
Bias Description: Self-control bias is the tendency to consume today at the expense of saving for tomorrow. The primary concern for advisors with this bias is a client with high risk tolerance coupled with high spending. For example, suppose you have an aggressive client who prefers aggressive investments and has high current spending needs and suddenly the financial markets hit severe turbulence. This client may be forced to sell solid long-term investments that have had been priced down due to current market conditions just to meet current expenses. Below is the survey question related to self-control bias.
 (View the related graphic here.)
Commentary: This answer shows that PEM investors have good self control. This is a good thing because people are living longer, will have medical bills to pay for, for longer and so on. This questions might have been answered quite differently two to three years ago. Most all investors are acutely aware of the need to increase savings.PAGEBREAK

Optimism Bias
Bias Type: Emotional
Bias Description: Many aggressive investors believe that bad investments will not happen to them--they will only afflict "others". Such an illusion can damage portfolios because people fail to mindfully acknowledge the potential for adverse consequences in the investment decisions they make. An example of optimism bias is when employees allocate a high proportion of their 401K plan as their company's stock because they think they know their company better than others and feel more confident in its prospects. Below is the survey question related to optimism bias.
 (View the related graphic here.)
Commentary: I couldn't have imagined any more fitting response percentage than this to this question. About 50% of the respondents see the glass half full and half see it half empty. Overly optimistic investor need to reflect on why they are so optimistic and adjust their behavior accordingly.

Illusion of Control Bias
Bias Type: Cognitive
Bias Description: The illusion of control bias occurs when people believe that they can control or, at least, influence investment outcomes when, in fact, they cannot. Aggressive investors who are subject to illusion of control bias believe that the best way to manage an investment portfolio is to constantly adjust it. For example, trading-oriented investors, who accept high levels of risk, believe themselves to possess more "control" over the outcome of their investments than they actually do because they are "pulling the trigger" on each decision. Below is the survey question related to Illusion of Control bias.
(View the related graphic here.)
Commentary: Perhaps the wisdom of this group of investors who took the survey is showing through. I would have expected more people to want to pick their own numbers. But this group clearly understands that with lottery, as with investments, is largely a probabilistic endeavor. For those who like to pick their own numbers, be advised that this is largely a fruitless exercise.

Hopefully you have learned something about how PEM investors are biased and how you might begin to think about counseling them when you encounter these biases. In next month's article, we will be discussing the biases of investors who use financial advisors.

Michael M. Pompian, CFA, CFP, is an investment consultant to ultra-affluent clients and family offices and is based in St. Louis. His book, Behavioral Finance and Wealth Management, is helping thousands of financial advisors globally build better relationships with their clients.


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