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The 2010 Behavior Survey: Conservative Biases

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

Michael M. Pompian, 07/15/2010

Last month I began a series of articles examining the results of a practical application of behavioral finance survey that I recently did in partnership with MorningstarAdvisor.com. The purpose of the survey was to gauge investing behavior and choices and how influential these choices are in the investment decision making process. The survey was also done to learn more about the four Behavioral Alpha investor types (that we have been reviewing over the past two years) and how financial advisors can be better prepared to work with them.

The population of survey-takers 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 more than 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 proactive, engaged and self-directed investors, and this, naturally, is only a subset of all investors. For simplicity, I will call the investors who took the survey "PEM investors" going forward: proactive, experienced, and male. It's insightful to examine how prevalent each behavioral bias is in the population of PEM investors, because we tend to think of investors older than 60 years old as those who should have a somewhat risk-averse posture toward their portfolios. What we have in this survey are fairly risk-tolerant investors who are in the later stages of their lives. In addition, research has shown that male investors tend to be more risk-tolerant than female investors. And even risk-tolerant investors, regardless of gender or age, will have biases associated with conservative investors. Here's how the survey-takers answered questions related to biases of conservative investors and some commentary about this data.

Loss-Aversion Bias
Bias Type: Emotional
Bias Description: Some investors feel the pain of losses more than the pleasure of gains as compared with other client types. As such, these investors may hold only losing investments too long--even when they see no prospect of a turnaround. Below is the survey question related to loss aversion bias.
(View the related graphic here.)
Commentary: Given the fact that we are dealing with PEM investors, this result is somewhat surprising in that I would have expected the number who would hold and get back to even to be lower than 57%. Why? Because many experienced and self-directed investors are often able to rationally look at a situation and cut a losing investment and move on. With 57% of survey-takers seemingly subject to loss aversion, this demonstrates that even experienced, self-directed investors can still become quite affected by loss-aversion bias.

Status-Quo Bias
Bias Type: Emotional
Description: Some investors prefer to keep their investments (and other parts of their life for that matter) the same or keep the "status quo." A direct application of this bias is the following question.
(View the related graphic here.)

Commentary: This is a very encouraging sign and somewhat expected of PEM investors. The fact that nearly 88% prefer a buy-and-hold strategy tells me that this group has discipline and doesn't waste money on trading costs. Moreover, respondents tend not to get emotional about their investing especially during market turmoil.

Endowment Bias
Bias Type: Emotional
Bias Description: Some investors assign a greater value to an investment they already own (such as a piece of real estate or an inherited stock position) than they would if they don't possess that investment and had the potential to acquire it. Below is the survey question related to endowment bias.
(View the related graphic here.)
Commentary: I am skeptical of the large number of "no" answers to this question. It is common for survey takers to answer questions based on how they think they should answer questions as opposed to how they actually behave. With that said, this is an encouraging sign that even if some portion of the 80% of survey-takers weren't genuine in answering that they don't get emotional about possessions or investments, they recognize that they shouldn't get emotional! Hopefully they learned something about themselves when answering the question!

Regret-Aversion Bias
Bias Type: Emotional
Some investors avoid taking decisive actions because they fear, in hindsight, that whatever course they select will end up being less than optimal. Regret aversion can cause some investors to be too timid in their investment choices because of losses they have suffered in the past. The following is the question regarding regret aversion bias.
(View the related graphic here.)

Commentary: I would have expected a slightly higher number of people to admit that they had regret bias. Regret is something that is quite common with investors. However, there are some PEM investors who clearly look at investing as a probabilistic endeavor and don't let regret cloud their judgment.

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