Behavioral Finance – The Independent

Behavioral Finance – The Independent

Are you an innovative thinker, willing to hold your own opinions?  Do others describe you as strong-willed, individually-minded, and self-confident, unafraid to involve yourself in new and unfamiliar areas?  Were you active in creating your own wealth, and do you maintain that control by staying active with your investments?

If so, you may very well be an Independent.  In behavioral finance, we’ve identified four major personality types, or patterns of how we act: Accumulator, Independent, Follower and Preserver.  Our personality plays a major role in determining our strengths and weaknesses in decision-making, especially around finances.  Back in June, we discussed the most daring personality type, the Accumulator.  This article will cover the next one: the Independent.

What are common financial blind spots for Independents?

An Independent is rarely content to “go with the flow.”  In every area of their lives, whether health, career, parenting, or finances, Independents form their own opinions. And, since they are willing to educate themselves first, their opinions are often very reliable.  As a result, instead of blindly following teachers, doctors, or other professionals, Independents look to them as consultants while still giving the final say themselves. This self-reliant nature gives Independents an advantage over other investors.

And yet, the informed judgment of Independents is not enough to ensure financial success.  We all have certain blind spots, or gaps in our thinking, that keep us from always acting in our own best interests. Independents in particular should watch for these five common pitfalls: Conservatism, Availability, Representativeness, Self-Attribution/Self-Protecting, and Confirmation Biases.

Conservatism Bias

First impressions are often hard to change. Once Independents develop a positive or negative opinion about an asset class (such as small-cap stocks or high-yield bonds) or investment vehicle (such ETFs or hedge funds), it can be difficult for them to shift gears, even in the face of new evidence opposing that view. This bias may keep an Independent’s portfolio under-diversified by holding either too much of a favored investment or too little of a less-favored one.

Availability Bias

Name a famous actor. Your response probably reflects what you’re most familiar with, such as a recent movie you enjoyed or your favorite genre. Likewise, we tend to make investment decisions based on data most easy to recall, usually from recent events, personal experience, press coverage, and short-term trends—not always the most reliable sources!

Representativeness Bias

Independents often classify new concepts into mental “buckets” based on past knowledge. While this approach can be an efficient organizational tool, too little data might lead to using the wrong bucket for a new concept. For example, an investor may believe that all fixed income instruments are “safe” investments, causing them to lump together aggressive, high-yield “junk” bonds with much more conservative US Treasury bonds.

Self-Attribution/Self-Protecting Bias

Self-preservation is a fundamental human trait.  In a desire to protect themselves, however, Independents may take credit for successful investment returns while blaming failure on outside factors (e.g., a weak economy or a firm’s lackluster financials). This attitude can lock Independents into poor habits, dooming them to repeat the same investing blunders. The best way to protect against this bias is by objectively learning from past mistakes.

Confirmation Bias

No one likes being wrong, and that includes Independents. Some may focus only on facts that agree with their beliefs or ignore others that go against them. This attitude can lead to an overly optimistic outlook for a previous investment decision even in the face of obvious, glaring red flags.

How can an Independent overcome these biases to achieve financial success?

How can Independents overcome their natural blind spots? First, don’t be afraid to be “wrong.”  We all want to be right and so avoid situations, people, and facts that don’t affirm us. Ultimately, however, this attitude only hurts ourselves.  When we ignore the other side, we potentially cut ourselves off from important facts. Remember, no one is perfect; be open to opposing views, and you may find yourself pleasantly surprised with the results.

Secondly, do your research. Independents are naturally deep thinkers, which comes in handy when considering all relevant facts, not just the most available sources.  Finance is filled with seemingly small nuances that make a world of difference.  Back to our previous example, an investor who considers all bonds the same might swap US Treasuries for high-yielding “junk”, resulting in a significantly riskier portfolio.

Finally, be open to help.  While the internet gives us nearly unlimited access to data, there is no substitute for an experienced professional, especially for your hard-earned wealth. Financial planning is as much an art as a science.  Learning about the various tax, investment, and legal implications is only the start; knowing how best to apply these facts comes only with years of practice.  With the help of a trusted financial advisor, you can confidently make the best decisions for you and your family.

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