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The 2010 Behavior Survey: Biases of Growth-Oriented Investors

Here's our attempt to connect behavioral finance theory with real investors.

Michael M. Pompian, 09/16/2010

This article is the fourth 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 Growth-Oriented Investors
Conservatism Bias
Bias Type: Cognitive
Bias Description:
Conservatism bias occurs when people cling to a prior view or forecast at the expense of acknowledging new information. Growth-oriented investors often cling to a view or forecast, behaving too inflexibly when presented with new information in their quest for portfolio gains. For example, assume an investor purchases a security based on the knowledge about a forthcoming new product announcement. The company then announces that it is experiencing problems bringing the product to market. The growth-oriented investor may cling to the initial, optimistic impression of the new product announcement and may fail to take action on the negative announcement.  Below is the survey question related to conservatism bias.
(View the related graphic here.)
Commentary: The plethora of answers related to welcoming new information seems like a stretch to me. This is a classic case of how people think they should answer the question versus how they actually behave. In my experience I have seen many an investor stick too closely to their beliefs about investment they make based on their own research. Advisors need to monitor their clients' behavior related to conservatism bias because clients often don't realize they are engaging in this behavior.

Availability Bias
Bias Type: Cognitive
Bias Description:
Availability bias occurs when people estimate the probability of an outcome based on how prevalent that outcome appears in their lives. People exhibiting this bias perceive easily-recalled possibilities as being more likely than those prospects that are harder to imagine or difficult to comprehend. As an example, suppose a growth-oriented investor is asked to identify the "best" mutual funds. Many of these investors would perform a Google search and, most likely, find funds from firms that engage in heavy advertising--such as Fidelity or Schwab. Below is the survey question related to availability bias.
 (View the related graphic here.)
Commentary: These numbers appear to be in the range of being right. However, my experience tells me that more than a third of these types of investors make financial purchase decisions based on name recognition. Again this is a bias that is difficult for investors to realize they are engaging in. Advisors themselves need to monitor their own behavior for this bias as well--often the mutual fund companies that market themselves the most tend to be recommended the most.

Representativeness Bias
Bias Type: Cognitive
Bias Description:
Representativeness bias occurs as a result of a flawed a perceptual framework when processing new information. To make new information easier to process, some investors project outcomes that resonate with their own pre-existing ideas. A client might view a particular stock, for example, as a value stock because it resembles an earlier value stock that was a successful investment--but the new investment is actually not a value stock. For instance, a high-flying biotech stock with scant earnings or assets drops 25% after a negative product announcement. Some investors may take this situation to be representative of a "value" stock because it is cheap; but biotech stocks don't typically have earnings while traditional value stocks have had earnings in the past but are temporarily underperforming. Below is the survey question related to representativeness bias.
 (View the related graphic here.)
Commentary:  This is a bias that is not easily perceived so I was glad to see that at least 23% of the survey population said they were subject to the bias. It is likely that even more were subject to the bias but they couldn't imagine themselves in this situation. Investors can fool themselves into believing that a current investment has the same characteristics as a prior investment (a mental shortcut) especially when the prior investment was successful. With advice and guidance this bias can be overcome.

Self-Attribution (Self-Enhancing) Bias
Bias Type: Cognitive

Bias Description: Self-attribution bias refers to the tendency of people to ascribe their successes' innate talents while blaming failures on outside influences. For example, suppose an investor makes an investment in a particular stock that goes up in value. The reason it went up is not due to random factors such as economic conditions or competitor failures (the most likely reason for the investment success), but rather to the investor's investment savvy (likely not the reason for the investment success.) Below is the survey question related to self attribution bias.
(View the related graphic here.)
Commentary: Either the group of survey takers are very humble or they actually don't like to take credit for successful investments! In any case this is a good sign that a majority of respondents believe that investment success is based on external factors such as the economy or industry conditions. Advisors can leverage this to their benefit; when an investment or asset class doesn't work it can typically be explained by external factors.

Confirmation Bias
Bias Type: Cognitive
Bias Description: Confirmation bias occurs when people observe, overvalue, or actively seek out information that confirms their claims, while ignoring or devaluing evidence that might discount their claims. Confirmation bias can cause investors to only seek out information that confirms their beliefs about an investment, and not seek out information that may contradict their beliefs. This behavior can leave investors in the dark regarding, for example, the imminent decline of a stock.  Growth-oriented investors often find themselves subject to this bias. Below is the survey question related to confirmation bias.
(View the related graphic here.)
Commentary: Again, it appears as though we have a well-grounded group of survey takers. With over two-thirds of respondents seeking information that may contradict their thinking is very positive. There may be some gamesmanship going on with this question--but in my view it is a good thing that people recognize that they should seek contradictory information. Advisors need to keep their antennae on alert for this bias when working with clients who tend to do their own research and take appropriate course-correcting action when needed.

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 reviewing how PEM investors answered questions related to biases aggressive growth investors.

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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