When it comes to money and investing, following our instincts isn’t always the right choice. There are a number of biases that influence our decision-making, and to become a better investor, being aware of your own biases can help you make better investments. We sat down with 4 founders of investment startups to discuss investment biases, what you can do to overcome them and how their startups are helping investors tackle common behavioural biases.
“People can be overconfident about their abilities and this can lose you money”, says ikigai co-founder Edgar de Picciotto.
An overconfident investor is someone who has an over-optimistic assessment of their own knowledge and skills and believes that they have control of a situation. As such, these investors will think they are better than others at choosing stocks and at picking the right time to buy and sell.
Overconfidence bias is present in both retail and professional investors; one academic study found that 74% of professional fund managers questioned believed they were above average - a statistical impossibility. Another study, on retail investors, found that investors with the highest levels of overconfidence suffered the worst financial performance. Not only did they make worse stock picks than those with lower levels of overconfidence, the most overconfident investors were also more likely to be trading on margin, further increasing their losses.
“This is why digital wealth management platforms like ikigai are an advocate of investing for the long-term. It's a way to obtain returns from the market over the long run by investing in a well-diversified portfolio which also reduces the risk of losing money. It’s an investment philosophy that minimises costs, and your levels of stress as you just invest, hold and avoid looking at it too much.” explains Edgar.
Loss aversion is the tendency for people to prefer avoiding losses over obtaining gains, as proven in various experiments. Kelsey Willock, author of Not Your Boyfriend’s Investment Advice and Co-Founder of Tardi explains how loss aversion can hinder people from reaching their financial goals.
“Loss aversion is a cognitive bias many of us have (and particularly women) when investing. It took me years to overcome this bias myself, but after working for Goldman Sachs and learning the power of long term investing, I was able to take control of my finances and invest without fear. I am now building a business called Tardi to help others invest without fear and improve their psychological relationship with money. I want to help empower more people to get started, invest on their own terms and feel good about doing it.” says Kelsey.
Loss aversion bias is very common, and it’s why most people keep the majority of their wealth in cash due to fear they will lose money if they invest it. However, if you think about investing from a more long term perspective, you realize that you are actually losing more if you don’t invest. In the US, f you just keep your money in cash, you’re actually losing an average of 1.96% per year, due to inflation.
“You only hear in the news about the market going up and down but rarely about how the market, on average, has yielded 9% annually over the past 90 years,” says Kelsey.
Another investment mistake that can result from loss aversion is the disposition effect. It refers to a tendency for investors to hold onto loss-making investments for too long. Whilst a declining stock is still in a portfolio, the loss is only on paper and to many people feels less real and doesn’t trigger the same emotional response. As a result, some investors hold on to these loss-making investments in hopes of recouping their losses, while in reality they may be better off selling (tax loss harvesting measures), and reinvesting their funds in a more promising company.
Information bias is the belief that the more information one has, the better decisions they can make. Investors may look at past trends and believe it can predict the future, or they may rely on information that is not relevant. For instance, instead of looking at the intrinsic value of a stock, decisions are swayed by an overload of (irrelevant) information, such as daily commentary and share price movements or information shared on social media. A great example of this is the recent frenzy around stocks like Gamestop, with large mismatches between perceived investor value and value based on traditional metrics like company earnings.
“One of the hardest things for retail investors is understanding the intrinsic value of an asset class, including any wider market indicators, which are vital to evaluate before making a financial decision. For example, only considering past performance could mean you’re not actually getting an accurate picture of today’s intrinsic value and past performance is never a guarantee for future returns.” says Plend co-founder, Robert Pasco.
Especially when it comes to lending, the area that Plend focuses on, there is often an over-reliance on out-of-date data; data points that are 2-3 years out of date (or even 6 years, which is still common in the UK consumer credit market). While this outdated performance data may give investors an illusion of knowledge or control, it’s irrelevant information, explains Robert.
“Providing accurate information based on the intrinsic asset value is key to overcoming information bias, which is core to the product we have built at Plend."
Koia’s co-founder Richard Draper, points out that investors tend to buy a disproportionate amount of stocks from companies in their home market, due to a sense of familiarity with these companies. According to the Pension Protection Fund, around half of retail investors’ holdings in the UK are domestic stocks. At the same time, UK companies make up only 4% of equities in world indices today (MSCI).
There are a few potential risks that come with holding a large portion of investments in companies from one country. For instance, over the past decade the FTSE100 (index of largest UK companies) has seen slower growth than its American counterparts, largely due to a lack of technology stocks, which have seen strong growth rates. Investing in one market not only means there will be more concentration of sectors and less diversification.
An an easy way to overcome this is by geographically diversifying your portfolio through funds or buying shares in other markets. To take this one step further, investors could also look to diversify a portfolio with alternative investments. Assets such as fine wine or watches, have a low correlation with the stock market. As an added benefit, these tangible assets may provide you with the same sense of familiarity as a company in your home market.
“At Koia, we let anyone invest in what they know and love. Not only are the alternative assets Koia offers a way to diversify a portfolio, it also allows you to invest in something you understand and are passionate about,” says Richard.
At Koia, we allow you to start investing in tangible assets for as little as €50, via fractional investing. Our experts make sure to source and buy the best assets, and we take care of authentication, storage and insurance. All of the benefits, with none of the hassle.
The articles and information made available on Koia are provided for information and educational purposes only and do not constitute financial advice. You are advised to consult with an independent financial advisor for advice on your specific circumstances.