Be Wary of Investor Biases

Monthly ETF Allocation

Looking at the history of the general market and especially the US markets like the S&P500 and Nasdaq, investing is supposed to be easy.  Statistically, in the long run, the market gives some of the best returns on investment and usually outperforms inflation. So why do we as humans absolutely suck at this game? It comes down to human psychology and all our biases that wreak havoc on our investment decisions. A bias is an irrational assumption or belief that warps our ability to make a decision based on facts and evidence. 

Most investors use some sort of process when investing. This might include many steps like evaluation of various investment options (stocks, ETFs, bonds, real estate, crypto), fundamental and technical analysis and in-depth research. Unfortunately, this process is still full of psychological pitfalls. In order to make an optimal investment, it is important to reach an objective decision. It might be very useful to identify, understand and hopefully overcomes these biases. Below are three investor biases which most of us can relate to.

Hindsight bias

Hindsight bias occurs when an investor looks back at past events. They stare at the share price graph of a stock and falsely believe they could have predicted the moves. We have seen a lot of this going around with the last month's rally. 

I knew this would happen.

I knew this stock is going to explode higher.

It was obvious that this was the bottom.          

This psychological phenomenon allows investors to believe that they accurately predicted a future event after it has occurred. This brings a false sense of security and overconfidence in one's ability to predict other future events. The truth is that when new information comes to light about a past experience, we unconsciously change our recollection of that experience. It deludes investors into thinking that future events are more predictable than they really are and can lead to unnecessary risk-taking. 

Anchoring Bias

View anything that has happened up to the present point in time as history. Care about what you're going to do from the next moment on.  Paul Tudor Jones

Anchoring bias can cost us dearly, by missing out on great opportunities. Two ways this can play out: We can wait for a stock to fall to its recent low or some other reference price before we get in. This original reference point like a 52-week low might seem like a great entry point but there is no guarantee that the stock will hit that price again. Another instance is when we buy a stock and it falls immediately, once it gets back to break even we are usually tempted to sell. These reference points lead us to make decisions based on the past only, ignoring the future potential.

Confirmation Bias

This is certainly one that most stock fanatics fall victim to. We have a tendency to look for information, tips, recommendations and research that conforms to our own beliefs. We do this to reinforce our conviction, often at the expense of missing new insight and perspective. To be a great investor sometimes the best thing you can do is to understand the bear thesis. 

There are many other behaviours to be wary of like herd mentality, FOMO, trend-chasing, loss aversion and the disposition effect.

Keep all of these in mind when making your next investment.

ETF Portfolio Update Summary

Most of these biases mentioned above can be removed by Dollar-Cost Averaging into diversified ETFs and that is why this method is recommended for 90% of investors. We have made our monthly allocations to our ETF portfolio. 

We lowered our allocations to increase our DCA time horizon.

From this month we will add $100 to these 5 ETFs:

• iShares MSCI Emerging Markets ETF(EEM)
• iShares S&P Global Clean Energy Index ETF (ICLN) 
• VanEck Vectors Rare Earth/Strategic Metals ETF (REMX)
• Vanguard FTSE All-World ex-US ETF (VEU) 
• iShares Trust - iShares Global REIT ETF (REET)

$200 to these 5 ETFs:

• iShares Edge MSCI Multifactor Global ETF (ACWF)
• iShares Core S&P 500 ETF (IVV)
• Invesco QQQ ETF (QQQ)
• VanEck Vectors Semiconductor ETF (SMH)
• Vanguard Dividend Appreciation ETF (VIG)

Disclosure

This is not financial advice and only the opinions of the author.  This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products. The $28K in the ETF portfolio is not real money and only a demonstration of a typical portfolio.