We all act and react differently to periods of market stress. This is what makes our work with individual clients so interesting. We work hard to provide education based on evidence and these points flow through our ongoing efforts like this blog. Our approach is unconventional and the philosophy that we put into practice is not ordinary. That is purposeful.
Sometimes we learn lessons from the most unlikely people. We had an attorney client in a small South Carolina town for many years (he passed away several years ago). In times like those we are experiencing now, he would be sure to call and growl his unhappiness. For him, the behavioral bias that he exhibited most was what we call “anchoring”. This simply refers to focusing too much on a single piece of information, like original cost or the peak value in the past. This client, and many of us, have a tendency to “anchor” on a reference point even if that information has nothing to do with today. It can be a very limiting and dangerous bias if left unchecked.
To be blunt, the market doesn’t know your cost basis and that information has no relevance to market prices today. Our attorney client often compared his investment assets that we managed on his behalf to his timber land investments. In his mind, timber land always appreciated and stocks actually went up and down. Of course, the fact that real estate can’t be valued each day folded neatly into his narrative. Had he lived to witness the real estate crunch starting in 2007, he would have seen that, yes, even real estate prices can move in both directions.
A related and interesting emotion based phenomenon pushes us to “value” gains far less than losses. Numerous studies place the factor around 2 to 1. That is, the pain of loss is around 2 times the joy on the same amount of gain. For retirees, some studies suggest the pain ratio is 5 times that associated with gains. This can lead to serious decision making errors.
One of the most valuable aspects of our work with individual clients is helping to manage against behavioral biases. Ready for a real conversation?