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Managing Behavior in a Volatile Market

New survey analysis will look to identify key primary and secondary behavioral biases to give advisors a leg up on managing them.

Michael M. Pompian, 10/20/2011

This month's article starts a new series about managing behavior in a volatile market. The new series will provide data and insight into not only identification of key behavioral biases that your clients are likely to exhibit but also how to manage this behavior and emotion in this highly volatile market climate.
A substantial part of this series will be a review and analysis of answers to behavioral questions that were completed by a diverse set of 178 individual investors in 2011. The investors polled were not subscribers to Morninstar.com and/or Morningstar investor newsletter publications like the last survey, but they fit a similar profile in terms of investment objective and investor description. At the end of this article I will provide some demographic and other descriptive information on the survey-takers.

The survey questions were written to identify 20 key behavioral biases that I outline in my book "Behavioral Finance and Wealth Management."

The intent of the survey was twofold. First, I wanted to identify the most commonly occurring biases ("Primary Biases") so that advisors would know what to look for more easily when working with their clients.

Secondly, I wanted to identify what less prominent behaviors ("Secondary Biases") might also be lurking behind these primary biases. To use a simple example, if client ABC has easily recognizable bias X, what other of the 19 biases asked in the survey might Client ABC also be subject to?

The purpose in doing this research is that advisors can hopefully anticipate, based on recognition of a primary bias, what other biases a client might be subject to and manage the situation before the effect of the bias has taken hold. Often it is the unrecognizable biases that can cause substantial harm when attempting to keep clients on track to attain their financial goals. Advisors can hopefully gain significant insight into a range of a client's behavioral tendencies simply by being aware of a single common bias.

In order to rank as a primary bias, 50% or more of respondents needed to answer at least "Agree" or "Strongly Agree" to a question designed to identify a given bias. There were seven biases that garnered at least 50% positive responses; these were the following:

  • Loss Aversion Bias: the pain of losses is greater than the pleasure of gains
  • Anchoring Bias: getting "anchored" to a price point when making an investment decision
  • Hindsight Bias: believing that investment outcomes should have been predictable
  • Recency Bias: Taking investment action based on the most recent data or trend rather than putting the current situation into historical perspective
  • Representativeness Bias: Making current investment decisions based on how past similar investment decisions turned out
  • Status Quo Bias: Not taking action to change one's investment portfolio (i.e., doing nothing when prompted to do so)
  • Regret: Past (poor) decisions affect current or future investment decisions

A key idea embedded in the interpretation of the research is that if the same distribution of responses were applied to an advisor's client base, probability says that 1 out of 2 clients will be subject to these biases. Naturally, it will not be this easy or uniform with a real client base. Wouldn't you like to know what other biases a client is likely to have if they are subject to hindsight bias? Or loss aversion? Or any of the biases listed above?

The next seven articles will cover these seven biases in detail. Revealed in these articles will not only be survey results and discussion on managing the effects of these key biases but also identification of the "secondary" or less easily recognizable biases that can also affect investment decision making.

Examining bias questions such as those asked in the survey is very important and potentially very helpful to advisors who are trying to manage their client relationships in the most efficient and effective way possible in this highly uncertain market period. There are valuable insights into what clients are thinking from these respondents. 

As promised, the remainder of this article is a summary of the profile of the survey-takers. As you will see, these are independent-minded, risk-tolerant investors that represent a wide range of portfolio sizes and diverse age group populations. Note the high number of "Independent/Do-It-Yourself" investor types that characterize many Morningstar.com subscribers.

Investor Type

 Select the Phrase That Best Describes You as an Investor
Response Percent
Response Count
Asset Preserver
Advice Taker
Independent Thinker/Do-It-Yourselfer
Asset Accumulator


 What Is Your Age?
Response Percent
Response Count
Over 65

Investment Objective

 What Describes Your Investment Objective?
Response Percent
Response Count
Maximizing my total return potential:. I can accept a high degree of risk and price volatility.
Above-average returns: With few exceptions, I am willing to accept a moderate to high level of risk to achieve it
Preserving the money I have invested, but with enough growth to keep me ahead of inflation: I have a low to moderate tolerance for risk and price volatility.
Protecting my investments: I have a low tolerance for risk.


I hope you are looking forward to reading the next seven articles as much as I am looking forward to writing them! We will begin next month's article with a review and discussion of loss aversion bias. Thanks for reading!


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