The Investment and Wealth Institute’s 2021 Behavioral Finance Barometer report has the financial media buzzing about cognitive biases and their impact on investors. The BeFi report is the result of a survey on investment advisors regarding the impact of cognitive biases on their clients. What has everyone suddenly talking are the findings of the study, suggesting a significant increase in the effects of client cognitive biases. They also report which of the various coaching strategies meant to lessen the impact of those biases were most effective when working with their clients to help them reach their long-term goals.
Cognitive biases certainly are prevalent among investors and they have long impacted their decisions, but what happens when the cognitive biases of the respondents find their way into the report itself?
COVID and Cognitive Bias
The main thesis of the report is that the COVID-19 pandemic has resulted in unprecedented levels of cognitive bias amongst clients of investment advisors, it states: “Never has there been a more critical time for advisors to incorporate behavioral finance principles into the core elements of their practices”. This assertion is made because financial advisors surveyed for the report responded saying they noticed an increased influence in each of 14 cognitive biases presented by the study. The advisors surveyed were also asked about the effectiveness of 10 coaching strategies meant to limit the impacts of bias in their clients and all but two saw an increase in effectiveness.
These results are certainly interesting. Although it is refreshing to see financial advisors and media alike paying more attention to cognitive biases and behavioral finance, what is possibly more insightful is how the survey’s design allowed for the biases of the advisor respondents to nudge their responses, potentially compounding to make it seem like cognitive biases have a particularly strong grip on the market right now… but not during completely rational moments in market history like the Global Financial Crisis, Dot-Com Bubble, Black Monday, or even the onset of the Great Depression.
Human beings have always been susceptible to cognitive bias and investors are no exception. So, it is possible that the results of this survey are showing not just bias among the advisors’ clients, but also those of the advisors themselves.
Changing Clients or Changing Advisors
There are two reasons financial advisors would report that their clients are more impacted by cognitive biases than in the past: either their clients truly are more impacted by cognitive bias, or a convergence of other factors are making those advisors perceive an uptick when there is none (or it is not nearly as significant as reported).
One such potential factor would appeal to financial advisors’ recency bias, the tendency to be influenced by information received most recently. Financial media has finally started paying attention to behavioral finance and concedes that a host of cognitive biases have an impact on the decisions investors make. Financial advisors paying attention to financial media are now more likely to attribute their clients’ decisions to cognitive bias. More advisors are also using tools to gauge client behaviors as the practice of doing so becomes more accepted, meaning they’re more likely to notice biases that may have already been present.
There has also been a recent influx of new market participants. It is entirely plausible that advisors seeing a larger quantity of clients exhibiting similar levels of bias are interpreting that instead as an increased magnitude of bias among individuals. For example, an individual client’s passing interest in a speculative asset, say an obscure cryptocurrency, wouldn’t be much cause for concern. However, if an advisor had many clients expressing nominal interest in that same crypto, the sheer volume of inquiries might eventually give the advisor the impression that their clientele had a much stronger conviction in the asset.
Lastly, the way certain questions are subjectively worded in the study has the potential to result in inaccurate responses. For example, respondents were asked “To what degree do you believe the following biases may be affecting your clients’ investment decision making?” This allows for a wide range of categorical and qualitative responses from advisors essentially observing comparable degrees of influence. Certain questions are phrased to be self-serving to the respondents like “Which of the following techniques have proven to be most effective when working with your clients to help them reach their long-term goals?” Any advisor would want to say the techniques they are using to help their clients overcome biases have been “Very Effective”, especially given that they just reported how impactful those biases were on their clients.
What the Report Can Tell Us
This report isn’t sufficient to truly determine if an increase in the impact of cognitive bias on investment decisions took place over the last few years, nor is it able to accurately determine which of those biases have had more or less impact. Posing these questions to advisors and not to clients directly – and doing so in a non-clinical environment – has the potential to sway responses considerably. This is not to say that cognitive biases haven’t always had a strong impact on investor decisions. In fact, this report should highlight what we at OVTLYR have been saying all along: biases impact the decisions of nearly every investor. Everyone should try to compensate for their biases, understanding all the while that they will never be completely resolved. It also demonstrates that, despite their best efforts, you can’t just expect your financial planner to also be a miracle-working psychiatrist. They have biases of their own.
