The Leading Business Education Network for Doctors, Financial Advisors and Health Industry Consultants

By Dr. David Edward Marcinko MBA MEd CMP™

SPONSOR: http://www.CertifiedMedicalPlanner.org

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The study of behavioral economics has revealed much about how different biases can affect our finances—often for the worse.

Take loss aversion: Because we feel a financial setback more acutely than a commensurate gain, we often cling to failed investments to avoid realizing the loss. Another potential hazard is present bias, or the tendency to prefer instant gratification over long-term reward, even if the latter gain is greater.

When it comes to money, sometimes it’s difficult to make rational decisions. Here, are three behavioral financial biases that could be impeding financial goals.

ANCHORING BIAS

Anchoring Bias happens when we place too much emphasis on the first piece of information we receive regarding a given subject. Anchoring is the mental trick your brain plays when it latches onto the first piece of information it gets, no matter how irrelevant. You might know this as a ‘first impression’ when someone relies on their own first idea of a person or situation.

Example: When shopping for a wedding ring a salesman might tell us to spend three months’ salary. After hearing this, we may feel like we are doing something wrong if we stray from this financial advice, even though the guideline provided may cause us to spend more than we can afford.

Example: Imagine you’re buying a car, and the salesperson starts with a high price. That number sticks in your mind and influences all your subsequent negotiations. Anchoring can skew our decisions and perceptions, making us think the first offer is more important than it is. Or, subsequent offers lower than they really are.

Example: Imagine an investor named Jane who purchased 100 shares of XYZ Corporation at $100 per share several years ago. Over time, the stock price declined to $60 per share. Jane is anchored to her initial price of $100 and is reluctant to sell at a loss because she keeps hoping the stock will return to her original purchase price. She continues to hold onto the stock, even as it declines, due to her anchoring bias. Eventually, the stock price drops to $40 per share, resulting in significant losses for Jane.

In this example, Jane’s nchoring bias to the original purchase price of $100 prevents her from rationalizing to sell the stock and cut her losses, even though market conditions have changed. So, the next time you’re haggling for your self, a potential customer or client, or making another big financial decision, be aware of that initial anchor dragging you down.

HERD MENTALITY BIAS

Herd Mentality Bias makes it very hard for humans to not take action when everyone around us does.

Example: We may hear stories of people making significant monetary profits buying, fixing up, and flipping homes and have the desire to get in on the action, even though we have no experience in real estate.

Example: During the dotcom bubble of the late 1990’s many investors exhibited a herd mentality. As technology stocks soared to astronomical valuations, investors rushed to buy these stocks driven by the fear of missing out on the gains others were enjoying. Even though some of these stocks had questionable fundamentals, the herd mentality led investors to follow the crowd.

In this example, the herd mentality contributed to the overvaluation of technology stocks. Eventually, it led to the dot-com bubble’s burst, causing significant losses for those who had unthinkingly followed the crowd without conducting proper research or analysis.

OVERCONFIDENT INVESTING BIAS

Overconfident Investing Bias happens when we believe we can out-smart other investors via market timing or through quick, frequent trading. This causes the results of a study to be unreliable and hard to reproduce in other research settings.

Example: Data convincingly shows that people and financial planners/advisors and wealth managers who trade most often under-perform the market by a significant margin over time. Active traders lose money.

Example: Overconfidence Investing Bias moreover leads to: (1) excessive trading (which in turn results in lower returns due to costs incurred), (2) underestimation of risk (portfolios of decreasing risk were found for single men, married men, married women, and single women), (3) illusion of knowledge (you can get a lot more data nowadays on the internet) and (4) illusion of control (on-line trading).

ASSESSMENT

Finally, questions remain after consuming this cognitive bias review.

Question: Can behavioral cognitive biases be eliminated by financial advisors in prospecting and client sales endeavors?

A: Indeed they can significantly reduce their impact by appreciating and understanding the above and following a disciplined and rational decision-making sales process.

Question: What is the role of financial advisors in helping clients and prospects address behavioral biases?

A: Financial advisors can provide an objective perspective and help investors recognize and address their biases. They can assist in creating well-structured investment and financial plans, setting realistic goals, and offering guidance to ensure investment decisions align with long-term objectives.

Question: How important is self-discipline in overcoming behavioral biases?

A; Self-discipline is crucial in overcoming behavioral biases. It helps investors and advisors adhere to their investment plans, avoid impulsive decisions, and stay focused on long-term goals reducing the influence of emotional and cognitive biases.

CONCLUSION

Remember, it is far more useful to listen to client beliefs, fears and goals, and to suggest options and offer encouragement to help them discover their own path toward financial well-being. Then, incentivize them with knowledge of the above psychological biases to your mutual success!

EDUCATION: Books

SPEAKING: Dr. Marcinko will be speaking and lecturing, signing and opining, teaching and preaching, storming and performing at many locations throughout the USA this year! His tour of witty and serious pontifications may be scheduled on a planned or ad-hoc basis; for public or private meetings and gatherings; formally, informally, or over lunch or dinner. All medical societies, financial advisory firms or Broker-Dealers are encouraged to submit an RFP for speaking engagements: CONTACT: Ann Miller RN MHA at MarcinkoAdvisors@outlook.com 

REFERENCES:

• Marcinko, DE; Dictionary of Health Insurance and Managed Care. Springer Publishing Company, New York, 2007.
• Marcinko, DE: Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™. Productivity Press, NY, 2016.
• Marcinko, DE: Risk Management, Liability and Insurance Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™. Productivity Press, NY, 2017.
• Nofsinger, JR: The Psychology of Investing. Rutledge Publishing, 2022
• Winters, Scott:  The 10X Financial Advisor: Your Blueprint for Massive and Sustainable Growth. Absolute Author Publishing House, 2020.
• Woodruff, Mandy: https://www.mandimoney.com

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