Yet many clients have difficulty diversifying their portfolio in lieu of what they see as the highest returning asset class or the investment with the best potential moving forward. Portnoy points out that this tendency runs against the general principle of buying low and selling high.
“Because our old ways were focused on survival and any sense of danger that we feel is processed as a threat, we are wired with a deep bias of loss aversion to put more emotional value on what’s not working, rather than what is working,” said Portnoy. “The diversification conversation between advisors and clients is difficult and peculiar in ways that most people have never really articulated.”
Control Behavior
On a daily basis, investors are confronted by a huge amount of information, a portion of which often relates to their financial picture. Humans develop biases to help them sort through the large volumes of information for important details – but as these biases help reduce the amount of time it takes to collect and process information, they can also cause the omission of crucial data and lead to regrettable decision making.
“Our job is not really to beat the market, but to control ourselves,” said Portnoy. “Investors who end up in a good place tend to be aware of their emotions and capable of controlling hteir behavior.”
Biases may help explain why investors tend to buy and sell investments at inopportune times, causing them to underperform many of the funds and securities they hold.
Portnoy and Virtus list four emotional and cognitive biases that investors are prone to: overconfidence, confirmation, recency and mimicry.
In overconfidence, investors and advisors place a greater value on their own skills and opinions than is actually merited.
In confirmation, more emphasis is placed on already entrenched beliefs and decisions that are already made – information which confirms a client’s beliefs or decisions is accepted, while information which refutes their positions is rejected.
“Today, you can find any information you want to validate and confirm your belifes at any time,” said Portnoy. “As a result, that creates people and portfolios who are unwilling to change.