How behavioural biases affect the rationality of our decisions!

Traditional economics informed us that; people behaved in a rational manner, financial markets were perfectly normal and accordingly, investors acted rationally. Market thinking at the time regarding finance was always built on the twin assumptions of “Perfect Markets” & “Perfect People” but history clearly shows otherwise.

In retrospect, we can clearly see how behavioural biases were always at play and how they impacted on the financial markets of the day. The Tulip Bubble or Tulipmania in Holland immediately springs to mind, where owning tulips became a fad amongst the elite of Dutch society, so much so that at its height in 1637, a single tulip sold for the equivalent of €50,000 in today’s money. An enlightened buyer failed to show up one day for his purchase, and suddenly, panic (or probably more to the point, reality) spread. Literally, within days tulip values had fallen a hundred times – the bubble had burst!
Numerous other documented cases of this investor irrationality spring to mind, including the South Sea bubble of 1720, and in much more recent times we can all remember the madness with the Dot-Com or Internet Craze & Crash and the Subprime Mortgage Bubble to name but a few.
At a recent Financial Planning Standard’s Board seminar which I attended, Dr Peter Lunn from the ESRI posed the following question to an audience comprised mainly of financial advisers: If you were offered a free €10 bet, which of these two questions would you rather put that €10 bet on?
1) Is life expectancy in India greater than or less than 60?
2) Will Irish house prices go up or down in 2017?
Unbelievably, the majority in the audience went for number 2, believing they had a better knowledge of how the Irish property market was going to perform into the future, rather than bet on a fact about life expectancy in India. The result reaffirms that people are actually more willing to take risks on matters which they are familiar with (Familiarity Bias) than something else, which is in fact a certainty… Life expectancy in India is actually 66.21 years (World Health Organisation 2012).
This familiarity bias may well be harmless in most day to day situations, where we tend to shop at the same supermarket or eat out at the same few restaurants for example. When it comes to investing however, this familiarity bias can have significantly negative consequences. Employees, familiar with their industry tend to be over-weighted in their employers stock, think Bank of Ireland employee share options, or property developers, who, because they knew the property business inside out didn’t even consider looking at other alternative or more diverse options. In other words, please DIVERSIFY.

Another good example Peter illustrated on the day was to consider if it was possible or even probable that the creators of this ad were playing on the Loss Aversion heuristic: the fear of losing out on something now which you may not be able to get back later, if you don’t act? What do you think?
At Lifestyle Financial Planners, we are conscious these behavioural biases are at play and have designed a robust Investment Philosophy to help us help our clients in reducing their exposure to them.
Some simple rules to counter behavioural biases would be:
1) These biases apply to you, me and everyone else, not just everyone else
2) You know less than you think you do
3) Look for information that disagrees with you
4) Judge things by facts and statistics, not how they appear
5) Don’t overweight personal experiences or rules of thumb
If we want to make better decisions in our personal or working lives, and in society as a whole, then we ought to be aware of these biases. If, gauging from the familiarity bias example discussed earlier, financial advisers who should know better, are prone to be swayed…… how much more so then do you think the general public can be nudged, particularly when making financial decisions or looking at planning your Financial Future.

Get in touch today to arrange your free Discovery Meeting consultation.
Paul is the Managing Director of Lifestyle Financial Planners Ltd, has been in business since 1985 and offers specialist, tax efficient wealth management, retirement and estate planning solutions to our customers. Paul is a Certified Financial Planner and holds a Masters Degree from UCD in Financial Services and Risk Management.
Tel: 096-75951 Mob: 086-8053755, Email; web:
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Waiver: The information contained in this article is for general information only and cannot be relied upon as the basis for any form of agreement or advice. The author recommends that you seek independent tax, legal or financial advice relevant to your own particular circumstances.

Published May 16th,2017

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