Do you often follow the lead of friends and colleagues, whether in career moves, parenting styles, or stock picks? Are you content with decent investment returns instead of trying to “beat the system”? Are you open to others’ thoughts and opinions, not insisting on your own way?
If so, you may be a Follower. Behavioral finance gives us four major personality types: Accumulator, Independent, Follower and Preserver. So far, this series has covered the first two which have a mid-to-high appetite for risk. This article will focus on the next personality type, the Follower.
Caring, thoughtful, trusting, and amiable, Followers are loyal friends and coworkers. Followers are open to new cultures, work styles, and points of view. When it comes to investing, Followers prefer to follow others in financial decisions, leaving them to do the research.
What are common financial blind spots for Follower?
While Followers are content to “go with the flow”, watch out that “the flow” doesn’t lead down a less-than-desirable path. Followers tend to face five common pitfalls: Recency, Hindsight, Framing, Cognitive Dissonance, and Regret Aversion Biases.
Think of five US presidents. Most likely, the ones you named served in the White House in the last few decades. This is because we most easily recall recent happenings and events. Likewise, Followers tend to focus on recent market trends while overlooking longer-term patterns.
We’ve all had that same feeling: “I knew it all along.” Maybe a politician is arrested for bribery or an out-of-favor sports team pulls a surprise win. Although we’d honestly never have predicted it, once we see the outcome, we might “fill in the gaps” of our memory and convince ourselves that we knew it from the start. In the same way, investors often look back at unexpected market events, such as the infamous dot-com bubble or 2008 housing crisis, and think that they saw it coming. Because of this overconfidence in a still uncertain future, Followers may take too much risk and expose themselves to a costly surprise.
Every good salesperson knows the value of framing. “Our fertilizer will save 85% of your crop” sounds a lot better than, “The other 15% probably won’t make it.” In the same way, Followers need to guard against reacting to how an investment is presented (as either overly positive or negative) without examining all the pros and cons.
Cognitive Dissonance Bias
Everyone hates being wrong. When we learn that a decision may not have been as good as first thought, we can rationalize it to avoid feeling regret. For example, some investors may ignore negative earnings reports for a company they recently purchased to justify their purchase.
Regret Aversion Bias
Unlike Cognitive Dissonance, where we rationalize a poor decision to get rid of regret, Regret Aversion keeps us from taking decisive action just in case the results are less than optimal. After many costly structural damages, a family may decide never to own a home again to avoid risk. Similarly, Followers may refuse to invest in a particular asset class or investment vehicle (such as small cap stocks or interval funds) if they’ve had a poor experience in the past.
How can a Follower overcome these biases to achieve financial success?
First, get informed. While it’s easy to believe what we hear over and over again, the loudest voice isn’t always the right one. Take the time to verify sources and get second opinions.
This doesn’t mean that you need to become the next investment guru. Unless you’re a big statistics fan, we hardly expect you to start drawing candlestick patterns or calculating standard deviations! Learning the basic principles of investing gives you a major advantage. Our Bird’s Eye View blog is a great place to start. Each week we post on a wide range of financial topics, such as what a bond or ETF is or how to protect your wealth.
Secondly, follow the right people. From casual discussions around the water cooler to passionate news pundits, every day we are inundated with a flood of investing advice. How can we know what to trust? With all the noise, it’s vital to find objective, experienced help. Close friends and family members often fill this role. For those of us with more complex situations or larger nest eggs, a financial advisor can give professional care to ensure your finances are in good shape.
Finally, decide for yourself. This isn’t natural for Followers who’d much rather have others decide for them. They may struggle to trust themselves, especially in the important area of finances. However, only you know what’s best for you. Your old high school friend may or may not have your best interests in mind when he asks for funding on his latest tech start-up. Don’t let others to manipulate or dominate your thinking. Learn the basics, ask for help, but trust your gut feeling for the final verdict—you’ll be pleasantly surprised with the results!