During the Covid-19 crisis, investors have experienced extremes in market behavior that bring their behavioral biases to the surface, but advisors have many tools and techniques at their disposal to talk clients down from the ledge.

There are interventions that can be engaged both before and amidst market volatility to help people overcome their financial  behavioral biases, said panelists in “Behavioral Science to Help Investors During Strange Times,” a Wednesday session at the virtual 2020 Morningstar Investment Conference.

Of course, behavioral biases in investing and planning didn’t just arise out of the volatility spurred by the ongoing pandemic, said Steve Wendel, head of behavioral science at Morningstar, but volatility exacerbates harmful behaviors.

Behavioral biases are coping mechanisms like shortcuts and habits that help people make everyday decisions quickly without a lot of deliberation, said Samantha Lamas, a behavioral researcher at Morningstar. For example, when trying to choose which restaurant to eat dinner at, most people won’t closely research 20 or more restaurants in a certain area, but will open up Google or an app like Yelp to find a restaurant that has been highly reviewed—a form of herd following that “usually works out.”

Researchers like Lamas have identified hundreds of such biases and issues, but the Morningstar panelists focused on a few that have been particularly prevalent in the time of Covid-19.

“We’re all prone to overconfidence in our trading behavior,” said Lamas. “When we ask people to rate their own driving ability, a majority of us will answer that we believe that we’re above-average drivers, but that can’t be possible. Even after me telling you that, I bet you still think you’re an above-average driver.”

Lamas said that Morningstar’s research has found that men are more confident than women when it comes to investing, and that’s one reason men tend to trade more, experience higher portfolio turnover and achieve lower returns than their female counterparts.

The market recovery since the March lows may have investors feeling overconfident, warned Wendel, and advisors should emphasize that the future is always uncertain.

Recency bias is our tendency to overweight events and information that we have encountered recently.

Morningstar uncovered potential recency bias in investor goal setting, said Lamas.

“When an investor is asked, they may say goals that sound important and reasonable, but those goals may not be their true investing goals,” said Lamas. When Morningstar asked investors to identify their 30-year financial goals before and after experiencing a brief behavioral intervention revealing some of the risks encountered in financial planning, more than 70% of the respondents changed at least one of their top-three goals. “That means a majority of people out there could be working towards the wrong goals right now.”

When asked their goals, investors may not know the right answers, so they fall back on biases that provide a shortcut to an answer, typically whatever is at the top of their minds, said Lamas. If an investor had recently attended an open house or a housewarming party, for example, the first goal that may come to mind is purchasing a home.

Recency bias can be detected by the language that clients use, said Wendel. Typically, a display of recency bias is phrased as "this just happened, so  this is going to continue," with a short-term focus.

“There are a variety of techniques to help prepare for that moment,” said Wendel “The way in which we interact with the markets matters. An early study on traders and brokers on Wall Street selling and buying stocks found that the more often the traders got updates, the more it worked on their behaviors. The more information changes them, the more fearful they get in their trading behavior.”

Setting limits on how often asset allocations and account balances are reviewed helps investors think more long term and avoid being steered in a wrong direction by recent events, said Wendel. Lamas also recommended that advisors “fight vivid with vivid”—replace images of investment losses and red or negative numbers with images of long-term goals and ideal outcomes.

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