The decision-making mechanics of the average investor can’t be described in dollars and cents, according to Laura Coviello, vice president and senior portfolio manager for Brinker Capital Investments, an Orion company.
Investor decisions are better described in terms of ideas and beliefs, and are shaped by the concepts of behavioral finance, she said.
“Behavioral advice accounts for the messiness of human nature,” said Coviello today at Financial Advisor’s Invest In Women conference. “When you think about finance, it’s usually all about dollars, cents, quantitative models and fundamental analysis, but really there are people behind all of that with their own thoughts, feelings and ideas about the world which are driving the decisions they make about their portfolios.”
The human brain is an exceptional consumer of resources, explained Coviello. Though it accounts for 2% to 3% of human body weight, it consumes up to 25% of the calories a person takes in. Thus, the brain is always looking for ways to take shortcuts.
It is in these shortcuts that behavioral biases are formed, she said.
Here are six biases that Coviello has seen in clients in recent years:
Anchoring Bias
Coviello uses store sales as an example of anchoring bias. If someone saw the same pair of shoes twice, once being sold for $100 at a store, and again being sold at $100 but marked down from $500, most of the time they will instantly ascribe that $500 value to the shoes.
In the same way, a client who comes to an advisor with $8 million, enjoys a big 25% gain to grow their wealth to $10 million, but then loses 5% to end up with $9.5 million, will usually think of themselves as having experienced a $500,000 loss rather than a $1.5 million gain, said Coviello.
Confirmation Bias
Human beings naturally seek and retain more information that matches their already established beliefs and assumptions, said Coviello.
“When you get information that doesn’t come from what you already think, you’re going to put a lower weight or importance on that information versus information that aligns with your framework,” she said. “Information that doesn’t align creates cognitive dissonance and makes your brain have to work harder.”