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Behavioral biasses and how psychology impacts financial decision making

Hand holding a frame

Behavioral biasses and how psychology impacts financial decision making

Struggle to stay objective when faced with market volatility?

Here’s what Danny Chang, Head of Managed Investments and Products Management have to say:

Behavioral biasses and how psychology impacts financial decision making

Over the last 40 years the wealth management industry has coalesced to set up investment frameworks to enable retail participation and yet investors’ returns are lagging behindFull Article is to be found in the accompanying word document.

“The investor’s chief problem — and even his worst enemy — is likely to be himself”, wrote Benjamin Graham, a 20th-century American economist and a famed value investor. The catchphrase sums up that one of the most significant factors that determines investment returns is human behaviour.

Over the last 40 years the wealth management industry has coalesced to set up investment frameworks to enable retail participation and yet investors’ returns are lagging behind. Across most markets, stakeholders and regulators worked together to put in place a framework that makes it easy for retail investors to participate and benefit from market activity. Thus, supported by a mature industry, retail investors should be able to do better than the average.

The reality, though, is quite the opposite. There is growing evidence that the actual investor returns are significantly lagging behind the benchmark indices across markets by seven percentage points. Why is this so? The answer is error-prone behaviour of perfectly smart and logical investors. In other words, behavioural biases — scenarios often characterised by illogical and often irrational decisions — have the greatest impact on investors’ decisions.

Investors are susceptible to the pitfalls of behavioural biases as their emotions, beliefs and cognitive inability to process information clouds their judgement and decision-making ability.Often, we mistakenly think we know more than we actually do, and in this act of self-deception we miss the information we need to make an informed decision. At other times, we let emotions get in the way of our decision making and derail our rational thought process. For example, the global financial crisis in 2008 might have put you off from investing in financial markets. However, every dollar you invested in stocks back then, would be worth three times as much today. If you prefer investing in real estate, here is another example. According to the Bank for International Settlements (BIS) residential property index for Malaysia, every dollar invested in property in the country is only worth half as much as that invested in stocks over the same period.

Setting goals

How then, do investors keep calm when facing periods of instability and high volatility? Well, in times of uncertainty, it is crucial that investors concentrate on what they can control, rather than reactively focusing on elements that are out of their control, such as markets, economies and policies.

In such instances, I would recommend a systematic goal-based approach to investing.

Align: Linking your investments to a financial goal helps you see the link between your actions and their outcomes. One approach would be to establish a systematic investment plan in which a certain sum is deployed periodically. This approach helps you to stay focused on the objective of the investment instead of worrying about the short-term impact of market volatility.

Diversify: Volatile market conditions can hit individual asset classes hard, risking the devastation of returns for investors growing only one crop. Aim for a well-diversified portfolio that is aligned to your goals to ensure your investments can thrive under any conditions.

Seek expert advice: The risk of completely self-managing finance is the higher probability of various biases “silently” making their way into your portfolio. Good, independent financial advice goes a long way in terms of managing behaviours and emotions to make consistent, sound investment decisions in the face of extreme volatility. Be aware, too, that an independent adviser may also be subject to similar biases. Ideally, opt for advisers who formulate an investment strategy using a team approach to reduce bias.

While human conditioning and behaviour are difficult to change, there are ways to overcome the negative influences of behavioural tendencies. These are biases, that if acknowledged and remedied, can significantly improve the odds of meeting benchmark returns.

There is plenty of research that shows that there are two approaches to decision making — reflexive (gut feeling) and reflective (methodical). By focusing on the process rather than the outcome, an individual can adopt a more scientific, reflective approach to decision making and avoid acting solely on gut feeling. The same research also recommends having a well-conceived, structured plan around your financial goals and pre-committing to it. In the words of Warren Buffet, pre-committing to a systematic investment plan is important because it helps you with “the temperament to control urges that get others into  trouble”.

As a simple first step, roughly estimate how much of your total income is going toward spending, giving, saving and investing. Then ask yourself if that is how you want your money allocated and adjust accordingly.

Take a step back

It is also advisable to take a step back and review one’s decisions, especially in emotional upheavals. Avoid making an important investment decision when you are fearful, greedy and excited. Good investing is mathematical, so if you find yourself in an elevated state of mind, it is not a good place to be in terms of doing anything with your money.

This is where a wealth management adviser comes in handy in helping one avoid mistakes driven by behavioural biases. They know their client and with the strategies they have put in place, they can help the client stick to the plan and do what he or she is supposed to do. Research shows that the portfolios of people who work with an investment adviser do 2% to 3% better on average per year than those who do not, and that is a lot of money. So, 3% a year can double your wealth over the long term.

At Standard Chartered, wealth management advisers harness the best of technology to help clients prepare an investment plan, focus on the process and reduce the influence on behavioural biases that cloud good judgement and sound financial decision making.

Our framing technology helps you overcome biases by enabling you to visualise your financial goals and calculate how much you need in savings to achieve them. Framing helps you determine what financial goals you can realistically achieve or if there is a need for a change in your current spending pattern to accommodate future financial commitments.

We back that up with research and market insights. The solutions we offer are designed using a teambased, dialectic debate of the pros and cons, always seeking views on both sides of outcomes we predict. The advisers at Standard Chartered provide clients with detailed reports on products as well as their investment portfolios. Portfolio-level reporting helps take away the focus from product level performance and helps mitigate the emotional influence on decision making.

Reviewing portfolio investment performance is an important activity that should be done when the customers are in a good frame of mind without the stress of normal distractions. This is powerful from the perspective of helping our clients manage their wealth more efficiently and without biases. The natural inclinations to seek out information, look for patterns, compare options, and even flee to safety, are necessary to keep us out of harm’s way. But these same emotional tendencies are also our biggest liability when we are in investing mode.

The biggest threat to achieving financial independence is your own brain. You can invest in all the right things, minimise fees and taxes and even diversify your holdings. But if you fail to master your own psychology, it is still possible to fall victim to financial self-sabotage.

Behavioural biases that cloud investor decisions

Loss aversion

People feel the pain of losing money much more deeply than the pleasure of making it. To avoid distress, one might hold onto investment losses for too long or sell too hastily when markets recover after a sharp decline, robbing them of the long-term return potential needed to grow their savings and achieve their life goals. The more one experiences losses, the more prone he or she is to loss aversion.

Risk aversion

Simply put, we do not like uncertainty. Given a choice, we would often go with the known, even if the unknown might be more financially rewarding. This is why many people stay in familiar but unfulfilling jobs instead of changing careers or starting their own businesses.


As humans, we cling to the status quo because trying something different can result in a painful loss or a frightening uncertainty. This bias is particularly strong when it emerges alongside the loss aversion bias. For example, investors who suffered from the 80% decline in Malaysian equities during the 1997 Asian financial crisis may not be willing to consider any further stock investments.


People who feel more financially secure than they actually are may spend too much or not save enough. Or, they may be overactive traders who believe they can time their investment decisions to beat the market and end up doing the opposite.

Confirmation Bias

People often look for evidence to confirm their beliefs and disregard information that contradicts it. This bias limits our ability to make informed decisions by evaluating factors from a different perspective.

Under confidence

Only one in 10 retirees feels comfortable spending theirretirement savings, often because they lack the confidence that their money will last. This is called lifestyle risk — the risk of not enjoying the quality of life you can afford and worked hard to achieve.

Herd mentality

People often buy stocks to keep up with their peers. We tend to do what everyone else is doing, even when our circumstances are completely different. They are influenced by emotions and instinct rather than independent methodical analysis.


Positioning is when someone makes a decision because of the way information is presented to them rather than making decisions based on facts. In other words, if someone sees the same facts presented in a different way, they are likely to come to a different conclusion about the information. Investors may pick investments differently, depending on how the opportunity is presented to them.

Home Bias

A belief that one is more knowledgeable and aware of investments closer to home than overseas. Consequently, this results in investment decisions that are concentrated, or one may avoid new or unfamiliar territories away from current knowledge. If your investment portfolio consists largely of Malaysian or Asian stocks, you may be subject.

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All information is correct at the time of publishing.