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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.

Anchoring Bias
Bias Type: Cognitive
Some investors are influenced by purchase points or arbitrary price levels, and they tend to cling to these numbers when facing questions like "should I buy or sell this investment?" Suppose that the stock is down 25% from its high that it reached five months ago ($75 per share vs. $100 per share). Frequently, these clients will resist selling until the stock's price rebounds to the $100 per share that it reached five months ago.
(View the related graphic here.)

Commentary: Again, this result is not surprising to me. I would expect that more than 50% of survey-takers would answer this way because anchoring is a common bias. It is good to see that one third of investors have the discipline to sell and move on.

Mental-Accounting Bias
Bias Type: Cognitive
Many investors treat various sums of money differently based on where these sums are mentally categorized. If all of these assets are viewed as safe money, sub-optimal overall portfolio returns are usually the result.
(View the related graphic here.)

Commentary: This is the most surprising result out of this set of questions. I would have expected more mental segmenting of money. Perhaps the explanation is that "experienced" investors have a single portfolio generating income to live on and have already dealt with tasks such as saving for college.

Conclusion
PEM investors are moderately loss-averse, prefer a buy-and-hold strategy, don't get emotionally attached to their investments, sometimes regret their decisions and get anchored to the price levels at which they made investments, and tend not to segment their money into different accounts. Clear as mud, right? Actually, we can learn a lot from this information if we know where to look. In the largest sense, PEM investors with conservative biases are "reasonable" clients. What I mean is that they are fairly predictable in their behavior, and their biases are reasonably easy to work with. This is great news, because we want reasonable people as clients, right? On the positive side, they prefer buy-and-hold strategy and they tend to have one portfolio to deal with. In addition, they are moderately emotional in terms of regret and getting attached to investments. Classically, the concern is that they are loss-averse and get anchored to price levels, but this is very common, and if you know this you can effectively help them through these challenging situations when they arise.

So the next time you are dealing with a PEM investor with biases of conservative investors you will hopefully have a better frame of reference to dispense advice--which should enhance your relationship substantially!
 In next month's article, we will be reviewing how PEM investors answered questions related to biases of moderately risk-tolerant 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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