The Disciplined Investor

Five Ways to Strategize Your Behavioral Biases

Your brain can be quite tricky with some 95% of its activity occurring subconsciously.[1] With every spontaneous signal, our cerebral synapses expose us to countless behavioral biases, duping us into making misguided money moves long before our rational resolve kicks in.

These biases can affect our investing behaviors and decisions. We may leap before we look, making choices based on emotions rather than rational planning.

Because many of our most powerful biases are based on reflexive rather than reflective thinking, it’s not enough just to be aware of them. We must also learn how to defend against them. Or better yet, turn behavioral biases to our advantage. How do you do that? By tricking your brain right back.

Biasing Toward Better Behaviors

To illustrate this principle, here’s one “trick” that has worked incredibly well for retirement plan participants.

When companies started offering 401(k) retirement saving plans in the 1980s, employees were traditionally invited to participate but were not automatically enrolled. In other words, you had to take deliberate action to get started and increase your contributions over time.

Today, you can still decide if and how much you’ll contribute to your company retirement plan. But instead of requiring you to opt into participating, many companies now auto-enroll you unless you deliberately opt out. Your employer also may automatically increase your contribution rate to the maximum allowable amount over time, unless you say no. By requiring action to avoid saving for retirement, you can trick yourself into saving more than if you had to take action to start saving. Thus, we recruit our tendency to favor inertia, using it to improve on, rather than detract from retirement plan participation.[2]

Auto-Save Yourself

In their aptly entitled book, Nudge, Nobel laureate Richard Thaler and co-author Cass Sunstein refer to this sort of trickery as a “nudge.” As they describe it, nudges should not replace your free will; they should just make it easier for you to make your own best choices.[3]

Nudges don’t have to come from outside influencers, either. You can nudge yourself.

For example, we’ve long known about putting your personal saving habits on auto-pilot. In 1926, when George Clason first published his timeless classic The Richest Man in Babylon, he described this as learning to “pay yourself first.” By forming lifelong “pay yourself first” habits, you can replicate the same saving success found in the retirement plan world. The trick is to shift away from saving what’s left after spending. Instead, set aside your savings before spending the rest. In so doing, you’re once again using inertia to your advantage.[4]

Don’t Look Now

We’ve also long known how susceptible investors are to FOMO (fear of missing out), loss aversion, recency, and a bevy of other behavioral biases that trick us into chasing breaking news, rather than maintaining a more sustainable long-term perspective.

Reactionary trading can cost you. For example, an article in Canada’s The Globe and Mail, “Check in, freak out,” reported:

“A study conducted by U.S. robo-adviser SigFig found that its investors who checked in on their portfolios every day earned 0.2 per cent less each year in return than the average. Twice-a-day logins doubled the performance gap.”[5]

Watching the market’s bouncing ball can also leave you more unhappy than if you only check in periodically. As Nobel Laureate Daniel Kahneman observed:

“If owning stocks is a long-term project for you, following their changes constantly is a very, very bad idea. It’s the worst possible thing you can do, because people are so sensitive to short-term losses. If you count your money every day, you’ll be miserable.”[6]

So, don’t do that. Don’t let yourself look at the market’s daily news. Instead, nudge yourself to stay focused on what really matters by limiting your looks to quarterly, or even annual performance reviews.

Mental Accounting Tricks

Mental accounting is another behavioral bias that can help or hurt you. We’ve all engaged in it when we create arbitrary rules to “organize, evaluate, and keep track of financial activities” as described by Thaler’s paper, “Mental Accounting Matters”.[7]

The trick here is to be deliberate about which money management rules you establish for yourself, and why.

For example, imagine you’ve inherited some stock your mother held most of her life. You might subconsciously categorize these shares as legacy money and treat them differently than your other investable assets. Even if you’d be better off selling some shares to best preserve their lasting value, your mental accounting of what feels like “Mom’s Money” may stand in the way.

Instead of letting mental accounting hinder your best use of the inheritance, redirect it to make the most of her loving legacy. For example, you could consider selling the stock, accounting for most of the proceeds as “future wealth,” and reinvesting it accordingly in a less-concentrated manner (paying yourself first). You could then assign a portion of it to funding your kids’ college, and another batch of it for a fun family outing your folks would have loved.

While you’re not actually required to spend the money as accounted for, by effectively categorizing this money for these functions, you’re better positioned to enjoy the inheritance, without squandering it.

Blind Ambition

We’ve barely scratched the surface of strategies for turning your instincts and biases into wealth-building tools rather than weapons of financial destruction.

Arguably, one of our greatest behavioral foibles may be blind-spot bias, or our inability to see our own biases, even when we can readily spot the same tendencies in others.

Nobel Laureate Daniel Kahneman explored his own and others’ behavioral biases throughout his life. Among his greatest habits was to go out of his way to seek feedback from others, especially those whose temperament and perspective differed from his own. In his final publication, “Thinking, Fast and Slow,” Kahneman explains:

“We are often confident even when we are wrong, and an objective observer is more likely to detect our errors than we are.”

We believe one of the most important roles of an advisor is to serve as “a third-party observer” for clients, holding up a mirror whenever a blind spot may be blocking their financial view.

References

1. Nail, T. (February 20, 2021). Most brain activity is “background noise” – and that’s upending our understanding of consciousness. Salon. https://www.salon.com/2021/02/20/most-brain-activity-is-background-noise-cognitive-flux-consciousness-brain-activity-research/

2. Madrian, B. C. & Shea, D. F. (November 1, 2001). The power of suggestion: inertia in 401(k) participation and savings behavior. The Quarterly Journal of Economics, volume 116, issue 4 https://doi.org/10.1162/003355301753265543

3. Thaler, R H. & Sunstein, C. R. (February 24, 2009). Nudge: improving decisions about health, wealth, and happiness. Penguin Books. https://www.goodreads.com/book/show/3450744-nudge

4. Clason, G. S. (January 1, 2002). The richest man in Babylon. Berkley Books. https://www.goodreads.com/book/show/1052.The_Richest_Man_in_Babylon

5. Shufelt, T. (January 9, 2019). Check in, freak out: the ‘double-edged sword’ of real-time portfolio tracking. The Globe and Mail. https://www.theglobeandmail.com/investing/personal-finance/article-check-in-freak-out-the-double-edged-sword-of-real-time-portfolio/

6. Zweig, J. (October 14, 2021). From the archive: Daniel Kahneman. Jason Zweig. https://jasonzweig.com/from-the-archives-daniel-kahneman/

7. Thaler, R.H. (July 19, 1999). Mental accounting matters. Wiley Online Library. https://onlinelibrary.wiley.com/doi/abs/10.1002/%28SICI%291099-0771%28199909%2912%3A3%3c183%3A%3AAID-BDM318%3e3.0.CO%3B2-F

8. Kahneman, D. (October 25, 2011). Thinking, fast and slow. Farrar, Straus and Giroux. https://www.goodreads.com/book/show/11468377-thinking-fast-and-slow

 

 

Learn more about Saul Baumann

 

Hello! I’m Saul, a wealth advisor and financial planning specialist at Allodium Investment Consultants, located in Minneapolis, MN. I am dedicated to helping our clients reach their financial goals by specializing in investment strategies and comprehensive financial planning. When I am not advising clients, you will find me spending time with my wife, Khara, and daughter, Brielle. We live on a hobby farm, which supports my love of gardening and cooking. I have also been a downhill ski racing coach and enjoy outdoor activities, including canoeing, camping and photography.

 

The information provided is for educational purposes only and is not intended to be, and should not be construed as, investment, legal or tax advice. Allodium makes no warranties with regard to the information or results obtained by its use and disclaim any liability arising out of your use of or reliance on the information. It should not be construed as an offer, solicitation or recommendation to make an investment. The information is subject to change and, although based upon information that Allodium considers reliable, is not guaranteed as to accuracy or completeness. Past performance is not a guarantee or a predictor of future results of either the indices or any particular investment.