AN INTRODUCTION TO

B E H AV I O U R A L F I N A N C E
Understand how your mind thinks about money
F I R S T W E A LT H

“Watch the functioning of your

own mind in a calm and detached
manner so you can gain insight into
your own behaviour”
Henepola Gunaratana

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 F I R S T W E A LT H

INTRODUCTION

We’re all hard wired to make bad financial decisions, so recent EU Referendum result? House prices always rose in
don’t worry about it, it’s just the way things are! London, surely this would continue? Our house price was
It’s been a long time since I studied for my Economics higher in the summer before, and I was struggling to accept
degree, twenty years in fact and a lot has happened since that we would receive a lower figure now.
then. Starting off as a trainee financial planner back then, We finally managed to move in March 2017. On reflection,
I didn’t give the obscure Behavioural Finance module much I realised that a combination of behavioural biases where
more thought. preventing me from making this big decision. If this was
Roll forward twenty years, and I find myself fretting over affecting me in this way, surely our clients could be effected in
a big financial decision; to sell our house and move out the same way? As a financial planning firm, we therefore had
of London. My partner Petra was recovering from breast a duty to help educate our clients about the many biases that
cancer, and we now had a beautiful two-year-old daughter, could prevent them from reaching their ultimate goals in life.
Lux. With everything we had been through, we agreed that I dusted down my old Economics textbooks, and called
moving back to Dorset was the right thing for our family. But my client Professor Brett Kahr with my idea to put together
something was holding me back. Perhaps unsurprisingly, a book on behavioural finance. Our aim, to combine the
given my career, I was obsessed with the financial textbook theory with real life examples of how the biases
implications of the move. manifest in day to day decision making.
What if house prices continued to rise faster in London I hope you enjoy reading our book as much as we
than in Dorset? Was now a good time to move given the enjoyed writing it!

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F I R S T W E A LT H

INDEX

PART 1
INTRODUCTIONp5

PART 2
PROSPECT THEORY AND LOSS AVERSION p8

PART 3
AVAILABILITY AND REPRESENTATIVENESS p12

PART 4
THE LAW OF SMALL NUMBERS, GAMBLER’S FALLACY AND THE HOT-HAND EFFECT p17

PART 5
ANCHORING, CONSERVATISM AND HERDING p21

PART 6
OVERCONFIDENCE AND UNDER-CONFIDENCE p25

PART 7
SELF-SERVING BIAS p29

PART 8
PROJECTION BIAS & MAGICAL BELIEFS p32

PART 9
MENTAL ACCOUNTING p36

PART 10
NEXT STEPS – HOW WE APPLY THE INSIGHTS OF BEHAVIOURAL FINANCE p40

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 F I R S T W E A LT H

PA R T 1

AN INTRODUCTION TO
B E H AV I O U R A L F I N A N C E

Welcome to our series on we can ‘solve’ as such – behavioural

Imagine the scenario. You’re behavioural finance. Behavioural economics rests on the recognition
an avid football fan and you’ve finance (part of the broader field of that we’re all only human after all –
managed to get a ticket to behavioural economics), is the field of but having an awareness of them can
watch the World Cup Final. study that seeks to explain situations certainly help us in our approach to
You’ve paid £100 for the ticket, like the above. The situations where investing (and life in general).
but a friend offers you £200 real people make real financial In order to give some of the key
for it (assuming that you’re decisions that might not be easily concepts substance, and in an
legally entitled to sell it on). explained or predicted by traditional attempt to bring the theory to life,
You politely decline. A ticket economic theories. we’ve considered areas where the
tout offers you £500 for it. You Over the following pages, we’ll biases manifest themselves in real-
still say no. When you’re asked be looking at a different aspect of life decision making. I recently wrote
just how much compensation behavioural economics as a way about myself and my family moving to
you’d need to part with that of examining just how much our Dorset and the various questions we
ticket, you struggle to come decisions can be influenced by contemplated beforehand. Looking
up with a number less than a factors other than the cold, hard back, our decision-making process
huge, life-changing amount. calculations we might think we’re was affected by my loss-aversion,
And even then, if you took the making as informed investors. anchoring, status-quo bias and
money, you feel you might still We are all prone to biases and under-confidence – all of which we’ll
have regrets. emotional thinking. It’s part of being cover in this series. It’s no wonder it
human. These are not ‘problems’ took us so long to move house!

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F I R S T W E A LT H

The Sphere of straightforward as this. They The Revolutionaries

Behavioural Economics believed that traditional theories and the Birth of a New
Until a number of economists could only tell part of the story and Discipline
and social scientists mounted that if we wanted to understand In the early days of behavioural
a challenge to traditional and more accurately how we make finance, one of the economists
established thinking in the mid- financial decisions we would need leading the charge in this growing
1970s, established economic theories an approach that acknowledges the movement was Richard Thaler, who
didn’t offer a way to take human very human-ness of humans. was recently awarded the Nobel
behaviour into account. Broadly Our World Cup ticket dilemma is just Prize for Economics! He used to keep
speaking, economic theories were one example of the vast area that a list of anomalies that market-based
based on the assumption that in behavioural economics covers. It economic theories couldn’t explain
any given situation humans make exists at the intersection between on the blackboard in his office in the
rational, economically-sophisticated economics and psychology and University of Rochester. Below are
choices with all the relevant looks at the behaviours, biases and a couple of examples of the sort of
information to hand. beliefs that we all carry around with entries that made the list:
As a simple example, in the world us and employ when making financial The basketball fans who decide
of the traditional economic theorist, choices. It acknowledges the life not to use free tickets to a
the holder of the World Cup ticket experiences we all bring to bear on basketball game as the weather
in the above example would accept every decision we make, often in is too bad to drive there, but who
one of the offers to buy it above situations where we don’t have all agree that had they bought the
face value, because it makes clear the information to hand but need to expensive tickets they would have
economic sense to do so. By their make a choice anyway. Ultimately, it made the journey in a blizzard.
reasoning, it would be a sound and asks how we can hope to accurately The woman who would drive to the
successful economic exchange discuss the ways that people next town to buy a radio that was
and a rational decision that would make financial decisions without at being sold for £35 instead of £45
lead to an increase in the seller’s least an acknowledgement of all in her own town, but who wouldn’t
total wealth. the human factors that can affect make the same journey for a TV
A handful of revolutionary each one. reduced from £495 to £485.
economists and psychologists Thaler became increasingly
argued that it’s not quite as interested in these types of

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 <<< INDEX PA R T 1

anomalies and his list kept growing, out some questions you can ask
but he didn’t know what to do yourself as a way to keep alert to
PART

2
with it until he crossed paths with these biases and tendencies that
two psychologists called Daniel are present in all of us, and to help
Kahneman and Amos Tversky. keep them in check when making
Kahneman and Tversky were investing decisions.
establishing a way of understanding We’ll also be including key insight
common human decision-making and guidance from psychotherapist
errors as a result of the biases they Professor Brett Kahr. Professor Kahr
held. Between them, these three has worked in the mental health
academics were the founding fathers profession for over forty years.
of behavioural economics and He is Senior Fellow at Tavistock
behavioural finance. Relationships at the Tavistock
Institute of Medical Psychology, in
What Does It Mean for London, and, also, Senior Clinical
the Investor? Research Fellow in Psychotherapy
Our series will show how an and Mental Health at the Centre
understanding of behavioural for Child Mental Health in London.
finance can help investors, as well as Professor Kahr is a Consultant to
advisers, as they plan for the client’s The Bowlby Centre and a Consultant
financial future. In the following Psychotherapist at The Balint
posts we’ll be exploring a number Consultancy. Author or editor of ten
of concepts in this area of study, books and series editor of more than
including: projection and hindsight fifty other books, he is also a Trustee
bias; overconfidence and under- of the Freud Museum London.
confidence; self-serving bias; herding
behaviour; the Gambler’s fallacy; loss
aversion; and, mental accounting.
At the end of each post we’ll set

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PA R T 2

PA R T 2

PROSPECT THEORY
A N D L O S S AV E R S I O N

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 F I R S T W E A LT H

“It’s not as simple as gains are good and losses are bad. Sometimes both
gains and losses can be painful. Loss can feel like the most primitive form
of deprivation but with gains come a different type of pain. It’s common to
feel guilty about a gain – success is a good example of this – and the fear of
having to deal with the fact that your achievements have made you more
successful than those around you can have a debilitating effect on many
people. Also, the fear of losing that promotion you’ve gained, the feeling that
somehow you don’t deserve it or feel like a fraud can affect many people.”
Professor Brett Kahr

There’s a tipping point in the Prospect Theory be very different. In fact, the
birth of all new disciplines when Since the 18th century, economists struggle between the two is pretty
the scientist, or the economist, had assumed that we made cold, much what it means to be human.
or the psychologist senses rational, consistent decisions on Kahneman and Tversky set out to
that they’re on the brink of a the basis of what would result understand how humans actually
big discovery. That moment in in the optimal outcome for us as make financial choices, fully aware
behavioural economics arrived with individuals (called Expected Utility that they might uncover some
the definition of Prospect Theory. Theory, or EUT). However, Kahneman irrational findings.
The publication of Daniel and Tversky saw that economists The results of Kahneman and
Kahneman and Amos Tversky’s were using EUT as both a Tversky’s studies showed that
‘Prospect Theory: An Analysis of description of how decisions should people value losses and gains in
Decision Under Risk’ was the point be made as well as a description of dramatically different ways, and that
for behavioural economists when how they were being made. we tend to make financial decisions
the wave broke, the Eureka moment, As psychologists, this struck based on the size of potential gains
their equivalent of the day the apple them as absurd: they knew all too and losses – not on how much
fell on Newton’s head. well that how we should behave money we end up with. This result
and how we do behave can often contradicted the assumption that

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F I R S T W E A LT H

traditional economic theories had Implications for to your quality of life. A really great
always been based on, and thus Investors financial planner will tell you what
Prospect Theory was born. As In our role as financial lifestyle you need to hear as opposed to
investors, these findings can have planners, we ask clients to imagine what you want to hear. Sometimes
implications for how we manage our their ideal financial lifestyle scenario. that will be to help identify and
investment portfolio. We create plans that can put our counter potential threats. At other
clients on the road to achieving times, just as importantly, it will be to
Loss Aversion this lifestyle, but when it comes encourage you, inspire you, and to
Prior to the birth of Prospect Theory, time for our clients to take action, say, ‘you know what, you’re in great
economists thought that, as cold we often find that an aversion to financial shape to do this and I think
rationalists, we felt almost as good some perceived loss is holding them you should’.
about a gain of £10 as we felt bad back. The idea of losing their current It’s important for us as advisers
about a loss of £10. Kahneman and lifestyle can bring anxiety, even if to adapt to the personality of our
Tversky’s studies showed that this the switch is to something better. clients in these cases, and to build
often isn’t the case, and that we For example, many people up the necessary trust over time
dislike losing the money much more dream of selling their city home and to guide them throughout the
than we like gaining the exact same retiring to the country. However, journey. We do this by really getting
amount. In terms of how we behave some people can be prevented to know and understand the ideal
as financial beings, the implications from making this leap by the fear life they seek, and by building
are that people are ready to accept of losing out on a bigger pay-out their confidence with a plan and a
(or settle for) a situation when for the city house if prices continue portfolio to get them there. It’s not
there’s a reasonable level of gain, to rise. It’s common to come up just about putting the cash in an ISA
but will be much more prone to take against a situation where clients are and moving on, it’s about listening,
risks when they think they can limit hamstrung by their apprehension and matching the financial plan to
their losses. This behaviour is called of a loss that may or may not the lifestyle each client wants to
loss aversion. materialise. create. Having something to work
This situation is made more towards reminds us all why we get
difficult by the fact that financial out of bed every day: to achieve the
gains are much easier to define and goal of building our ideal life.
quantify than are improvements Professor Kahr shares this view

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<<< INDEX PA R T 2

on the importance of trust:

“Irrational behaviour in the making Questions to Ask
of financial decisions has its roots Yourself
in other realms of experience, well How strongly do you

beyond those restricted to finance agree or disagree

with the following
and investment. One’s decision-
statements?
making will often depend upon one’s
I hold on to investments that
pre-existing psychological character
I bought for more than their
structure; for instance, a person
current value in the hope that
might be excessive or impulsive they rebound.
or retentive, and these particular
I would be frustrated if an
characterological styles will inform investment increased in value
how he or she approaches monetary after I’d sold it.

matters. Financial advisers must I prefer to sell investments

take the time to build a relationship that have gone up since I
have bought them to
with people in a collaborative way so
those which have gone down.
that they can better understand the
I would rather cut my losses
vulnerabilities and idiosyncrasies of
and sell a stock than wait to
each client. This may well be crucial
see if it will bounce back.
to long-term investment success.”

PART

3
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PA R T 3

PA R T 3

AVA I L A B I L I T Y A N D
R E P R E S E N TAT I V E N E S S

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 F I R S T W E A LT H

It seems like every few weeks economists would argue that when making. In the case of lotteries,
we hear a story about a big we make choices in real life, we the highly available news reports
lottery win on the news. We never have every single piece of of jackpots, roll-overs and missing
might notice a work syndicate relevant information available to winning tickets floating about
has had a windfall; or maybe the us. Even if we did, in the context of might leave you feeling like it’s
three-week roll-over total has finally investing and the ever-changing about time the windfall landed in
been won by a lucky ticket-holder; nature of markets, it would be an your lap. Of course, the availability
or, tantalisingly, the winner of a impossible task to assess all of our of this information does nothing
jackpot three months ago hasn’t yet investment options and make a to change the minute odds of
claimed their prize, which puts us all categorically correct decision. winning, and so people regularly
on the lookout for discarded tickets. Instead, we make do with overestimate their chances of
With regular examples of these our limited understanding of scooping the big cash prize.
lucky winners all around us, have the situation, and we use short- People are very bad at estimating
you ever found yourself thinking cuts to help us make a choice. the probability of all sorts of rare
that the probability of a win Unfortunately, these short- events, and we often believe that
can’t really be all that remote? cuts can often include biases events happen more frequently if
I can’t speak to whether lottery that divert us from making the instances are easier to remember.
organisers have a good grasp of best choices in the moment for Sometimes, overestimating the
the fundamentals of behavioural what we want to achieve in the likelihood of a certain event is quite
economics, but keeping media future. The availability bias and beneficial: for example, it’s rare
stories about big jackpot wins representativeness bias are two for pedestrians to get hit by cars,
in the news will certainly help to examples of how what we hear and looking both ways before you
sell tickets. about a topic, and how that fits in cross the road helps keep it that
Traditional economists used with what we already think we know, way! However, when it comes to
to assume that investors were influences how we react to it. investing, gloomy economic news
all perfectly rational beings, who and stories about share price
possessed all the information Availability plummets or stock market crashes
they needed to make a financial Behavioural economists have found can have a disproportionate effect
or investment decision – but this that the availability of information on investors’ attitudes.
isn’t the case. In fact, behavioural greatly influences our decision- Access to too much information

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F I R S T W E A LT H

“Thinking about this more broadly, we know that people who

have experienced many betrayals or disappointments, perhaps
by parents, partners, or friends, can import this sense of mistrust
into their financial lives. In view of the widespread nature of
betrayal during early-life experiences, which damage our sense
of trust, the reliability of the financial adviser becomes deeply
important as a corrective.”
Professor Brett Kahr

can encourage a short-term focus we emphasise the importance of Representativeness

and too much tinkering with the being patient and sticking to the Whenever we encounter something
portfolio, which can destroy the long-term plan, but it’s only human new – an investment, a person, a
potential for good returns. This to be affected by news when it car, a business, anything – we tend
risk can be particularly salient for comes at us incessantly, and from to judge or categorise it on the
experienced investors – after all, so many different angles. The basis of how closely it resembles a
what information is more available natural tendency is to withdraw stereotype. Although we’re often
than your own memories? When or panic. As advisers, it’s our not consciously aware of them, we
people have had an experience with responsibility to remind our clients all use stereotypes when organising
a particular investment, they are that we are in this for the long things into categories and making
more likely to use that experience term, that every era has its stock decisions. Representativeness is a
(good or bad) to inform their market ups and downs, and that mental short-cut that people use
decision-making process in future. the best returns tend to be seen to decide if something belongs to
The ready availability of so much by investors who avoid short-term, a category on the basis of how
information in our society can be a knee-jerk reactions. well that thing represents the
problem for staying committed to stereotype. For example, if you are
investment plans. At First Wealth, introduced to a sportsman who is

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 F I R S T W E A LT H

seven feet tall and asked to guess We also find that many new “Thinking about this more
whether he is a high jumper or a clients have previously been told broadly, we know that people who
jockey, given what you know and to invest in companies who make have experienced many betrayals
understand about these sports, it’s products they like to use. This or disappointments, perhaps by
unlikely you’d guess he rides a strategy is risky, because a popular parents, partners, or friends, can
horse for a living. product can cause the company’s import this sense of mistrust into
Unfortunately, sometimes we share price to temporarily inflate their financial lives. In view of the
can be misled by stereotypes. beyond its ‘true’ value. In other widespread nature of betrayal
When it comes to investments and words, the fact that this company during early-life experiences,
financial planning, investors can seems very representative of the which damage our sense of trust,
mistakenly classify stocks in terms stereotypical ‘good investment’ the reliability of the financial
of supposedly shared qualities doesn’t necessarily mean it is more adviser becomes deeply important
with a stereotypical ‘good’ or likely to be one. as a corrective.”
‘bad’ investment. Sometimes this As financial advisers, we also Our aim at First Wealth, both
approach works, but other times it suffer from stereotyping of our own with individual clients and as
can leave us holding an investment profession, as slick, brash City- ambassadors of the industry,
that isn’t delivering the return we types who are only out to make a is to help restore that trust in
were expecting, or causes us to quick buck. In the current climate of our profession. We’ve set up a
reject an investment that would suspicion of financial institutions, it business that proudly rejects City
have paid off. can be difficult for advisers to win stereotypes, adapting our ways of
For example, it would be easy to trust. If a client feels like they have working to make ourselves more
assume that shares in a successful, been let down – or worse, misled approachable and warmer to clients
globally renowned company – by a bank or firm, they might be (for one – we don’t wear suits!).
represent a good investment. reluctant to get advice again or to Initially, this break with convention
However, this company’s success fully trust another adviser, which seemed scary, but it has succeeded
and future potential are probably can be frustrating for both parties. in removing the barriers between us
already reflected in their share As Professor Brett Kahr points and our clients, helping to reduce
price, so there may be limited out, finding it difficult to trust an any apprehension, or even fear, of
opportunities for making significant adviser might not be solely related seeing a financial adviser.
returns in future. to a client’s financial experiences: We have built our business to

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<<< INDEX

advise people not just on their

portfolios, but on what their
investments can mean for their
lifestyles, which provides a more
rewarding and fulfilling experience
for ourselves and our clients.

Questions to Ask
PART

4
Yourself
How strongly do you agree
or disagree with the
following statements?

I often buy and sell investments

on the basis of stories I read in
the news

I wouldn’t be put off a given

investment if I had previously lost
money on something similar

I prefer to invest in things that I

know well

I like to invest in companies whose

products I own and enjoy using.

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 PA R T 4

PA R T 4

T H E L AW O F S M A L L N U M B E R S ,
G A M B L E R ’ S FA L L A C Y A N D T H E
H O T- H A N D E F F E C T

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F I R S T W E A LT H

I really hope you’re enjoying ability to estimate probabilities of information. In some situations,
our Behavioural Finance series can often be skewed by human this approach might be valid. For
so far. In the first three parts instincts, which sometimes leads to example, if you have 10 red balls
we’ve covered prospect theory unconscious biases and irrational and 10 black balls in a bag and
and loss aversion, availability behaviour. randomly pick five consecutive red
and representativeness. And ones without replacing them, the
the great thing is, we’re only just The Law of Small odds of drawing a black one next will
getting started. Although we won’t Numbers increase. But in the case of tossing
be covering all of them, there are The law of small numbers is the a coin, each outcome is completely
a remarkable 188 cognitive biases. name economists give to a very independent of what came before
It’s little wonder that humans can common mistake people make when and what will come after. Every time
seem hard-wired to screw things up it comes to making predictions or you have an equal chance of getting
financially, or to make bad decisions gauging probability. The simplest a head as you do of getting a tail.
over and over again. example of it is when we toss a coin. There are a number of ways in
While these instincts represent a Every time we toss a coin there is which the law of small numbers can
significant threat to investors, they a 50% chance that it will land on bias our investing decisions.
can be a huge opportunity for great a head, and a 50% chance it will
financial planners. It is crucial for land on a tail. However, if we get a The Gambler’s Fallacy
a financial planner to understand run of, say, five straight heads, we The gambler’s fallacy describes how
these biases and how they affect might start to feel as if the next gamblers might expect, for instance,
their clients, so they can be well time we toss the coin there will be a number that hasn’t come up on
prepared for their clients’ reactions a higher probability of it being a tail. the lottery or on a roulette wheel for
to certain situations. Then they can This would be wrong because the a while to be ‘due’. These people are
help them to avoid errors and to outcome of each toss of the coin effectively making the same mistake
focus on making the right decisions has no bearing on the next one, so that’s highlighted by the coin-toss
over and over again instead. The the odds of each toss are still 50/50. example, but on a larger scale: their
value of this type of coaching over The reason we make this brain is telling them that they’re
the longer term can be enormous. mistake, according to behavioural dealing with a finite pot of numbers
In this week’s post, we look at economists, is that humans tend to that aren’t replaced once they’re
some more examples of how our put too much faith in small amounts picked. But actually, all numbers

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 PA R T 4

are available with every spin of the is ‘on a roll’ or ‘in the zone’ and that financial advisers in the behaviour of
roulette wheel. success will breed more success. their clients.
As with other biases, an It might seem at first as if the For example, if stock markets go
interesting theory of why our brains gambler’s fallacy and the hot-hand up for a period, as they have done
do this looks to our evolutionary effect contradict each other, but recently, some investors fear that
past. It might have been beneficial they both come from the same at any minute everything is going
to expect that a series of common place. In short, both make the to go into reverse. They announce
outcomes would be broken at some mistake of believing that past events they are not investing anymore
point: for example, the hunter who change the probability that a given as the market is sure to plummet
believes their luck will turn around event will happen in the future. In any day now. This could be seen
after a series of failures is much fact, far from being contradictory, as an example of the gambler’s
more likely to eat than the hunter we can imagine a scenario when fallacy – if the stock market has
who gives up. both the gambler’s fallacy and the gone up for a while, a fall must be
hot-hand effect are employed at the due. If we compare the rising stock
The Hot-Hand Effect same time: market example to how we think
While in some cases the law of Bob puts his lottery numbers on about house prices, we get a totally
small numbers causes people to for the week, being careful to avoid different reaction. When house
underestimate the chances of a numbers that have recently been prices go up, people say they are
particular outcome (as with the drawn [gambler’s fallacy], but he going to invest in property as it’s a
likelihood of seeing a run of five makes sure he gets his ticket from safe bet because prices always
heads in the coin toss example), the shop that has sold tickets to go up and they see no reason why
in others, it causes them to more winners than any other in his this won’t continue – this is the hot-
overestimate. Economists call this town [hot hand effect]. hand effect.
the ‘hot-hand effect’. The name The house price example also
comes from basketball and the The Effect on Investing touches on another topic we’ve
mistaken belief among fans and So how do these phenomena addressed in this series – the
players that the chance of a player translate to the everyday way availability bias. Because house
hitting a shot is greater following that we approach investing? The price crashes are relatively rare,
a hit on the previous shot, than a gambler’s fallacy and the hot hand there’s less available information
miss. It’s as if they believe the player effect can be spotted regularly by about them out there so we recall

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<<< INDEX

them less and fear them less. But or change our nappies, just as they
that’s not to say they don’t still did yesterday, and the day before Questions to Ask
happen and that the risk shouldn’t that. Great parents will gratify this Yourself
be considered properly. If we look magical thinking in infants and will How strongly do you agree
at the stock market example again, respond to the baby’s needs in the or disagree with the
conversely, if stock markets go most desirous way. following statements?
down, many investors then worry “Regrettably, financial markets do I am confident in my ability to time
they are going to sink even lower. not respond to our wishes as reliably the market when I buy and sell

They don’t arrive at the conclusion as good mummies or daddies may I wouldn’t consider an investment
that an upturn is due. As a result, have done. Thus, when infantile if I’d seen that it had recently

they don’t buy when they should, magical thinking seduces us into dropped in value

when the market is low; instead, believing that ‘all will be well’ with I worry about making an

they wait until it picks up and buy our investments, we run the risk investment at the wrong time.

when prices are rising again, missing of disappointing ourselves, often

the opportunity. This reflects hugely so. Therefore, it’s wise to
aversion to loss which we have also collaborate in a considered way with
looked at. trusted experts to help protect us
PART

5
There is a great deal of interplay from our vulnerability to the infantile
between the biases of behavioural thinking which lurks so deeply within
finance. Many of them have their our minds.”
basis in some of our earliest
childhood experiences. As Professor
Brett Kahr says:
“As every parent knows only too
well, newborn infants specialise
in what psychologists refer to as
“magical thinking”. In other words,
we magically expect that a mummy
or a daddy will automatically bring
us milk and biscuits, or will cuddle us,

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 PA R T 5

PA R T 5

A N C H O R I N G , C O N S E R VAT I S M
AND HERDING

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F I R S T W E A LT H

The way we receive and process irrelevant, provided the ‘anchor’ that Conservatism
information has a big effect on influenced the answer. Conservatism bias is related to
how we make decisions about We see this employed quite anchoring and happens when we
investing. In this section we look regularly as a sales technique. A see an investor clinging on to an
at some examples of these effects, second-hand car salesman might initial opinion about an investment
and consider how we can be alert to start the conversation with a high without properly incorporating new
common biases when exercising our price from which he expects to be information. They consider their
own investment choices. haggled down. Given the power of original view to be more meaningful
the anchor, he’ll probably end up with and important than any information
Anchoring a final price that will be higher than they learn afterwards. Typically, they
One of the most startling findings of had he begun with an amount closer take action on the basis of the old
the study of behavioural economics to the car’s actual value. information but are less willing to
is the research into anchoring. The property market provides act on new information that
Anchoring is the tendency to another a good example. If you have conflicts with it.
attach our thinking to a reference your house valued by a range of Professor Kahr explains some
point, even if the information has estate agents, they might produce of the factors that can inform our
no relevance to the decision we’re a variety of different asking prices. behaviour:
making. For example, a group of It is human nature to anchor on the
students in the US were told to write highest price. When people come to “Many people have a very primitive,
down the last two digits of their sell and find the house doesn’t fetch even irrational, relationship with
social security number, and then the top valuation price, this can stop money. For instance, when selling
asked to give a value to a number of them from moving on – even if it’s one’s house, the haggling might
randomly chosen retail products. The still a good price, provides a decent represent a deep-seated greed, but
results clearly showed that those profit, and the move is the right it might also serve as an indication of
with higher social security numbers decision according to their life plans. our fear of loss. Some owners might
gave the products higher values Sometimes, people can cling to set an unreasonable price because,
than those with the lower-digit social anchors as a reason for not taking at one level, they do not actually
security numbers. The social security action and for sticking with the wish to sell the house, since they
number, although completely status quo. have lived there with their family for

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 PA R T 5

a long time, and might fear a kind of of 1999-2000. Fund managers were one we come across most regularly
psychological homelessness.” investing huge sums of money in as advisers. Often clients can have
Professor Kahr further underscored: new internet-related ventures. It can an idea of the percentage return
“One’s private relationship with be particularly tempting to follow they are looking for from their
money may have nothing to do the crowd when you don’t have a investments – say, for example, 7%
with one’s objective net worth. full understanding of the situation – - and might be looking to see this
Many of us feel a sense of internal the reassurance of seeing so many level of growth consistently year on
impoverishment of character, often others doing the same thing can year. In the 100 years between 1917
due to early experiences of emotional exert a powerful influence (“all those and 2016, 7% has been the average
deprivation. Consequently, many people can’t be wrong, they must annual return for the FTSE All-Share
“rich” people with assets might know something I don’t!”). Index but the market will very rarely
actually consider themselves as Herd behaviour, following the return the average in a year. In the
never having enough money, partly crowd, conforming: whatever you call 30 years between 1987 and 2016
due to greed but, also, partly due it, it’s a common human instinct and the same index returned above 7%
to psychological loss, this sense of one that can impact investors and on 18 occasions (the highest being
internal impoverishment.” advisers in equal measure. Professor 30%) and below on 12 (the lowest
Kahr notes: being -32.8%).1 Given the portfolio
Herding Behaviour “Following the herd is a very is structured for the long term, we
Apparently, on the eve of the basic and primitive instinct in should build this level of fluctuation
1929 stock market crash, business human nature and relates to our fear into our expectations over the
magnate and philanthropist, John D of loneliness. It’s very difficult investment cycle. As advisers, we
Rockefeller had said that when the to go against the grain in all walks need to work closely with investors
bellhop in your hotel starts talking of life but particularly in investing to ensure that short-term anchoring
about share tips, it’s time to get when missing out on a financial doesn’t become the nemesis of a
out of the market. Whether this tale reward can put an investor in a long-term disciplined investment
is true or not, it certainly helps to very lonely place.” approach.
highlight the danger of herding when Time was when there only used to
choosing your investments. The Effect on Investing be a handful of funds to invest in. In
The most obvious example to cite Of all the biases we look at in this some ways, herding has reduced, as
from our era is the dotcom bubble series, anchoring is probably the there’s now a much wider mandate

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<<< INDEX

of investments to choose from.

However, the increased influence of Questions to Ask
Yourself PART

6
the media – particularly social media
– and the ability of investors to more How strongly do you
easily find a herd to follow could be agree or disagree with the
said to have increased it. following statements?
The demand for buy-to-let
I compare my investment
properties shows us this. The performance to how other
government has recently introduced investors have been doing

regulation to make buy-to-let a less I would not feel that my

attractive option, but it nevertheless investments were performing
well unless they were doing
remains popular. Many investors
better than the stock market
are keen to invest in property in the
I would be reluctant to sell an
belief that it will always increase in
investment that had decreased
value but, as we advise, this is not
in value since I bought it
always the case. Like any investment,
If a lot of people I knew had made
buy-to-let might make up a part of
a similar investment, I would
the portfolio but investing all your feel comfortable not seeking
money in it because everyone else is independent advice about it

doing it would not be something we

would recommend to our clients.
This is where the role of the
adviser is vital. It’s our job to offer
guidance based not on what
the most current craze is, but on
professional insight with an eye on
the long-term security and prosperity
of your investments.

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 PA R T 6

PA R T 6

OVERCONFIDENCE AND
UNDER-CONFIDENCE

PAGE | 25 PAGE | 25
F I R S T W E A LT H

“People who present as overconfident might, in fact, be hiding

significant insecurities and anxieties. They project an aura of
omnipotence as a creative defence against impotency. Such
a character style might stem from not having had sufficient
confidence in one’s sense of self, which generally derives from
security of attachment in early childhood.”

Next up in our 10-part series Overconfidence winning it, despite a host

on behavioural finance, we’ll As you can imagine, overconfidence of other competitors and the fact
be looking at the problems is not a trait that applies only to there can be only one winner? Much
surrounding self-evaluation. This those with an interest in investing. of competitive sport is driven by
is where we need to judge our own We’re all guilty of overestimating every single participant sharing this
skills, knowledge and competence or exaggerating our chances same belief.
related to investment decisions, to of success in any number of Surveys regularly show up
gauge how confident we can be in personal or professional situations. results where well over half of the
our own actions. Overconfidence isn’t driven by respondents rate themselves as
Self-evaluation is how we build incentives, it is innate — which comfortably above average, which
an understanding of our own makes it all the more powerful in its would be statistically highly unlikely.
successes and failures – whether we influence on our behaviour. (One of my favourites is the finding
think our actions are responsible for Instances of overconfidence are that 84% of French men estimate
them, or if they’re down to factors everywhere, inside and outside the that they are above-average
beyond our control. It can be one world of finance. Some examples at lovers1). Drivers also regularly rate
of the most difficult areas for us as play can reveal a minefield of blind themselves as above average,
individuals to address, because how spots. How many times in our lives in numbers far higher than 50%.
we evaluate ourselves is driven by have we taken part in a competition Entrepreneurial-ism in our society
deep-seated personality traits and or entered a contest with the belief would be far lower without the
our sense of self-confidence. that we could end up actually potent hit of overconfidence that

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 PA R T 6

powers the launch of so many new sense of self, which generally bad happening to us than the
ventures and start-ups. derives from security of attachment average. Under-confidence as a
When it comes to investing, in early childhood. Most people will whole can lead to inactivity and a
commentators have claimed that, struggle with a sense of confidence reluctance to take on the level of risk
‘no problem in judgment and at some point, as all of us began life necessary for an investor’s long-
decision-making is more prevalent as fragile babies. But in adulthood, term financial lifestyle goals.
and more potentially catastrophic the failure to accept advice from On a day-to-day basis, we
than overconfidence’. In an adviser’s a specialist may be a reflection of find that bad past experiences
experience, overconfidence and fear and vulnerability. The capacity can also leave investors with an
trying to be too clever in investing to receive advice from an expert under-confidence that is difficult
can often lead to too much tinkering adviser may very well be a good to shake. They might have been
with the portfolio. Clients who stick barometer of mental health.” inappropriately advised, taken on
to their agreed plans are the ones too much risk, or had their fingers
most likely to reap the best long- Under-Confidence burnt after investing unwisely.
term rewards. Looking for quick While not as prevalent and This can often result in a client
gains can often undermine or even pervasive as over-confidence, keeping all their funds in cash
destroy the capacity for growth over under-confidence can also have for fear it might happen again,
the life-cycle of an investment. a detrimental impact on our which can be a frustrating and
Overconfidence is common in investment activity. Research unrewarding position to find yourself
many situations and can arise for has shown that individuals can in. The presence of a trusted and
a number of reasons, as Professor underestimate their abilities and experienced financial adviser
Kahr explains: chances for success when making is vital to help clients navigate
“People who present as decisions about what investments their way through the peaks and
overconfident might, in fact, be to choose. There are particular troughs of overconfidence and
hiding significant insecurities and examples of investors being too under-confidence that all investors
anxieties. They project an aura of conservative about their own experience.
omnipotence as a creative defence performance relative to that of We formulate a plan which
against impotency. Such a character other people. We can also just be covers all elements of our clients’
style might stem from not having pessimistic, tending to think there’s financial position. It’s not vital that
had sufficient confidence in one’s a greater probability of something they understand all the minutiae

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<<< INDEX

and financial technicalities, but it

is important that clients know a
PART

7
plan exists and has been created
uniquely for them. Having a long-
term financial plan that is linked to
their life goals should give investors
the confidence that they can commit
to achieving the financial lifestyle
they’re seeking.

Questions to Ask
Yourself
How strongly do you agree
or disagree with the
following statements?

I still have high hopes for my

investments, even in the face of
some failed investment decisions I
have made in the past.

I often feel that I have little

influence over the things that
happen to me.

I am better informed about current

financial conditions than the
average person.

I am good at making financial

decisions.

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 PA R T 7

PA R T 7

SELF-SERVING BIAS

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F I R S T W E A LT H

In Part 6 we looked at We believe so deeply in our own and can have a joint effect on
overconfidence and under- abilities that when we see success how we make decisions about
confidence, which are both in our life, we’re not at all shy in investing: confirmation bias and
examples of self-evaluation bias. taking the credit for it and chalking self-attribution bias. Put simply, they
Now, we will look at another form of it all down to our skills, ability and are ways of confirming one’s existing
self-evaluation, in the shape of self- hard work. beliefs, or taking credit for success
serving bias. However, this self-congratulatory where it might not be due.
Every sports fan can recall outlook doesn’t end with just Confirmation bias: Imagine you
a game (probably many) where claiming all the credit for success. just heard some private news about
they felt wronged by the result, Here, we get selective again, a company that you own shares
the conduct of the players, or the because as well as claiming in, or you received a tip about a
decisions of the referee. Some fans responsibility for success, we have future investment opportunity. In
seem to live in a permanent state a tendency to reject responsibility the case of confirmation bias, when
of victimisation, always feeling hard for failure. We prefer to put failure we get this new information we
done by in one way or another. down to factors outside of our tend to interpret it in a way that is
Diego Maradona’s ‘Hand of God’ goal control, like the impact of other consistent with our prior beliefs; we
against England in the 1986 World people or just bad dumb luck. Self- see it as confirming what we already
Cup in Mexico is an example that serving bias can even be seen in believed. Perhaps you decide to act
English people often cite as one of the way governments talk about the on the tip, because you felt all along
the greatest sporting injustices of all economy. In economic good times, that this company was on the verge
time. But it’s unlikely it’s viewed this it’s all down to the incumbent party’s of inventing the Next Big Thing –
way in Argentina. This disparity is an shrewd economic policy; in bad that is confirmation bias at work. It
example of self-serving bias, where times, it’s down to uncontrollable can also work in the opposite way
we selectively interpret the world to global market forces or the mistakes when, for example, we discount new
suit our own beliefs and convictions. of the previous administration. information that conflicts with our
It’s not just in sport that we previous beliefs by ignoring it or
display this partisanship, but in Confirmation bias and choosing not to act on it.
many aspects of our lives we are self-attribution bias Self-attribution bias: We see self-
often our own biggest fans and our Self-serving bias has two attribution bias occurring when we
own most enthusiastic cheerleaders. components, which are similar are quick to attribute our successes

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 <<< INDEX PA R T 7

to our own purposeful and held, is the right one. You will only her patients or clients to confront
intentional actions but ascribe our listen to information that supports some often-unpalatable truths in a
failures to factors out of our control. what you already believe. sensitive and digestible manner.”
This reaction is seen as a form of Another problem for an investor
self-protection or self-promotion. with a strong self-serving bias is that
they may not be able to accept the Questions to Ask
Implications for information an adviser gives them. Yourself
investors This, in turn, can be problematic How strongly do you agree

We see confirmation bias for a relationship based on trust. or disagree with the

everywhere in our lives. One Being selective with information and following statements?

example is in the papers we read, blaming other factors if things aren’t I tend to get all my financial

choosing titles that align with our working out is not the way to plan news from the same one or
two sources.
own political views, or even in the for your financial future. It is about
friends we keep, spending our time being open to accepting guidance I can remember more examples
of times I was proved right by
with people who share and amplify so you can take responsibility for
the markets than times I was
our own outlook on life. your finances. If you don’t do it, no proved wrong.
For investors, the problem one else will.
When it comes to investing, I
with confirmation bias is that This phenomenon is common in believe I am in the best position
the tendency to editorialise the everyday life also, as Professor Kahr to decide what’s right for my

information coming their way could explains: money.

lead them to make mistakes that “The self-serving bias offers

have a negative effect on their us not only a temporary sense of
returns. Investors could be ignoring psychological comfort – often false
potentially valuable information comfort – but, in more extreme PART

8
or confirming misplaced views, instances, it might represent
meaning they end up with a one- an attack on truth, sometimes
sided understanding of a situation. approaching delusional proportions.
The root of confirmation bias lies The psychotherapist, like the
in overconfidence and a belief that financial adviser, must endeavour to
your own view, or the initial view you find a diplomatic way to help his or

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F I R S T W E A LT H

PA R T 8

PROJECTION BIAS &

MAGICAL BELIEFS

PAGE | 32
 PA R T 8

We’ve considered a range of could lead to problems in gauging assumption that they will remain
biases already in our series on future expenditure correctly, and generally healthy. The correct level
behavioural finance. Next we will incorrect assumptions about the of insurance is as important to your
look at ‘projection bias’ and how money we might need to set aside financial planning as the make-up
it can impact on our investment for retirement. It’s common to think of your portfolio. As advisers, we
decision-making. We’ll also be seeing that we won’t need as much money regularly ask clients big questions
how ‘magical beliefs’ can bewitch in retirement as we do when we’re about life, death and health, which
the superstitious investor. working, but with more time on our can be uncomfortable for clients
hands our expenditure can increase who have never engaged with these
Projection Bias in ways we hadn’t expected, topics before. However, our job is to
Although we may not recognise particularly on leisure and holidays. make sure clients have planned for
it by name, we’re all familiar with There’s also the problem of the all eventualities, including the curve-
how projection bias can affect us ‘ostrich mentality’ when people balls that life can throw at us, which
in everyday life. It’s when we make refrain from projecting altogether, can affect your finances but have
the mistake of thinking that our and just bury their head in the sand nothing to do with investing – like
preferences in the future will be hoping that everything will work incapacity, illness or death. It can be
identical to the ones we have in the out somehow. At First Wealth, we easy for an adviser just to go along
present. An example of this is when conduct a ‘Where Are You Today?’ with the client when they reject
we find ourselves hungry while we’re questionnaire with clients, along insurance, but it’s our responsibility
in the supermarket, which can often with cash-flow modelling, to work to make clients understand how
lead to a trolley full of food we don’t out how to get them from the vital it is, and that they are not
need, and a bigger bill to boot. The present day to the ideal retirement immortal or immune to illness. For all
mistake we make is thinking that in they want. This helps investors new clients, we recommend income
future we’ll be as hungry for all this to understand how their financial protection, critical illness and life
food as we are when we’re in the future is directly shaped by the daily cover to make sure they and their
supermarket. decisions they make in the present. families are protected for these
Projection bias is the tendency to Inadequate insurance cover can eventualities.
assume that our needs, tastes and be another example of projection Professor Kahr gives his insight
preferences will stay the same over bias in action. Many people waive on why we find it difficult to address
time. In financial planning terms, this critical illness cover under the questions of our health and

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F I R S T W E A LT H

Each of us begins our life in a

helpless, infantile state in which we
have no option but to depend upon
the care-giving of others.
Professor Brett Kahr

mortality head on: Magical Beliefs can somehow result in a change

“Each of us begins our life in a Magical beliefs don’t sound like for the worst, even though the
helpless, infantile state in which we a concept you’d expect to come circumstances are completely
have no option but to depend upon across in a discussion of economic beyond our control, can also affect
the care-giving of others. Thus, we theory – perhaps seeming more our financial decision making.
project all responsibility outwards. In suited to the pages of J.R.R. For some people, rising share
view of our vulnerability, growing up Tolkien. However, they’re the name prices can make them wary about
becomes a challenge as we must, behavioural economists give to investing their money in the stock
step by step, learn to become less certain preoccupations we have as market, lest the markets start to fall
dependent upon our parents. It humans that have a real effect on as soon as they buy. These people
should not surprise us that, during our decision-making, but that are end up sitting on their hands and
times of stress, we regress to more difficult to fit into more scientific watching the market go up, trying
infantile states of dependency and categories. We usually refer to them to pick the perfect time to invest. As
we wallow in a state of helplessness as superstitions. any good advisers will say, it’s ‘time
and denial. This applies not only to After two days of sunshine in the market’ rather than ‘timing
our intimate relationships but also and warmth at the beginning of a the market’ that will bring results.
to our business affairs, as we run British summer, rushing out to buy Drawing up and sticking to a long-
the risk of denying adult realities sunblock and deck chairs, then term plan is a far more reliable route
and of projecting responsibility booking the week off work would to your financial goals than short-
onto others.” be considered to be ‘tempting term gaming of the market. As an
fate’. This belief that our actions adviser with an eye on the markets

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 <<< INDEX PA R T 8

at all times, I too can be tempted to people-first approach. If you would

cash in on some of my own long- like some help in planning your ideal
term investments if they have done financial lifestyle, please feel free to
well, but I have to remind myself of get in touch.
the commitment I’ve made over the
long-term. I try to coach myself in
the same way I coach my clients.
Questions to Ask
Speaking of magical beliefs,
Yourself
How strongly do you agree
when choosing a financial advisory
practice, some investors can find or disagree with the
following statements?
themselves bewitched by the
mystique and prestige of some I often expect investments to
decrease in value shortly after I
of the more traditional firms.
buy them.
Long-established firms tend to
I won’t need to think about
be long-established for a reason,
passing on my estate until I’m
and they can point to past and
closer to retirement.
present success that underpins
I’m confident my financial
their reputation. However, what’s
situation in retirement will be
important for investors is that they better than average.
choose the advisory practice that’s
right for them, not the one with the
highest profile or the longest history.
First Wealth is a young, modern,
PART

9
forward-thinking practice, which
might suit some investors better
than a bigger, traditional firm. Our
business is our baby and we work
hard to provide a bespoke,
individual service that completely
satisfies our clients and reflects our

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F I R S T W E A LT H

PA R T 9

M E N TA L A C C O U N T I N G

PAGE | 36
 PA R T 9

Mental accounting is The summer holiday spending can be spotted in how we treat
everywhere. We use it every money is not to be touched under money we have won or found.
day. It’s so omnipresent that we any circumstances, even though Studies have shown gamblers
barely realise we’re doing it, but delaying paying off their credit card are much more liberal and less
once you become aware of it, will only cost more money in the emotionally attached to money
there’s no avoiding it. As an idea, long run. Rational economic theory they have won in a casino than
it sprang from a question economist says that it’s a no-brainer to use the they might ordinarily be with their
Richard Thaler asked himself one money in the piggy bank to pay off funds. There’s a sense that losing
day in the late seventies: ‘How do the debt. However, once someone it doesn’t harm or hurt us as much
people think about money?’ And in has marked the piggy bank money because we haven’t budgeted for it
his own words, he’s been asking it as too important to be touched, this and it’s come to us through
ever since: emotional connection can make it good fortune.
“I have continued to think, write very difficult to use the cash for any
and talk about mental accounting other purpose. Sunk Costs
for the rest of my career. It is a lens There can also be advantages We introduced this series on
that helps me understand the world. to mental accounting. As we have behavioural finance with an
Thinking about mental accounting seen, there can be downsides, but example of two basketball fans who
can be contagious. You may soon sometimes I believe it can actually decided not to use free tickets to
find yourself blurting, ‘Well that really help a certain type of investor to a basketball game as the weather
is a mental accounting problem.’ think of their money as occupying was too bad to make the journey,
In short, mental accounting is our different ‘pots’. It encourages but who agree that had they bought
tendency to think about money as investors to ring-fence a portion the expensive tickets they would
being marked for different purposes. of their funds – for example, their have attempted to drive through
As an example, someone might children’s school or university fees – the blizzard. This is an example
have a large credit card bill they and conditions them not to touch it of how we’re unable to ignore
need to pay off over a number of as it’s “not their money”. The same ‘sunk costs’. Sunk costs are the
months. At the same time, they applies to retirement savings, if it name economists give to things or
keep a piggy bank of spending encourages people to set sufficient services we’ve paid for that we can’t
money on the kitchen table to funds aside for the future. get back. Another example is over-
save for their summer holiday. Other cases of mental accounting ordering at a restaurant but keeping

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F I R S T W E A LT H

“In psychotherapeutic work, we often observe the

notions of ‘sunk costs’ and ‘mental accounting’,
especially in relation to troubled marriages.”
Professor Brett Kahr

on eating until you’re bloated and worth. I explained that the amount Den who has been pitching their
queasy because you’ve paid for that has been spent on the home product for so long that they can’t
the meal and you don’t want to is irrelevant if it’s not being used seem to give up and accept it’s not
‘waste it’. Traditional economists and, also, that any renovation work going to be a success. They stick
would say that as we can’t get sunk will be included in the value when with it as they’ve already invested
costs back, we should just ignore sold. However, the reluctant seller so much time in it. As investors, it’s
them, even if we’ve chosen badly. remained reluctant. So, I changed important to remind ourselves that
(To be fair, behavioural economists my tack and asked if they would what’s happened in the past has
would say this also, they would just be more open to selling it if it was gone and we need to make
acknowledge that doing so is far agreed that they would earmark all our decisions based on where we
from easy). the proceeds solely for holidays and are today.
Investing in property can be enjoying themselves in future. They Professor Brett Kahr has
a good example of this. At First said yes. Sometimes, as advisers, underscored:
Wealth, I met with a couple who we need to be creative in finding a
owned a holiday home. One wanted way forward! “In psychotherapeutic work, we
to sell it as they rarely used it, the Sunk costs don’t just apply to often observe the notions of ‘sunk
other wanted to keep it as they money, they can also apply to an costs’ and ‘mental accounting’,
spent a significant sum renovating investment of time. We’ve all seen especially in relation to troubled
it and wanted to get their money’s a hopeful entrepreneur on Dragon’s marriages. For instance, couple

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<<< INDEX PA R T 9

psychotherapists frequently
encounter partners on the brink of Questions to Ask
divorce who ask themselves, “Is this Yourself
marriage still a good investment? How strongly do you agree
After all, we have sunk a lot of
or disagree with the
time and money and emotion into following statements?
this partnership. Should I remain?”
Having multiple investment
In other words, will one’s large accounts is a good way to
investment in another person still distribute money among

reap significant dividends? In such different goals.

circumstances, couples often have I would rather spend dividends

difficulty deciding for themselves, on luxury purchases than

reinvest them.
in view of the profound mixture of
love and hatred, of tenderness and I would be less likely to sell an
investment that had lost money
disgust, and of loyalty and infidelity
since I bought it.
which scar so many intimate
marriages over time; therefore, just
as many of us will require a good
financial adviser to help us with our
‘mental accounting’, so, too, might PART

10
we need the services of a good
psychological professional to assist
us likewise.”

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F I R S T W E A LT H

PA R T 1 0

NEXT STEPS – HOW WE

A P P LY T H E I N S I G H T S O F
B E H AV I O U R A L F I N A N C E

PAGE | 40
 PA R T 1 0

Throughout our 10-part series on do this even more effectively. at First Wealth, an appreciation of
behavioural finance, we’ve seen Twenty years ago, giving behavioural finance will play a huge
how our own biases and beliefs financial advice meant selling part not just in this trust-building
can affect our investment financial products and packages, exercise but also in the future of the
decisions and the knock-on and earning commission. The world financial advice we offer.
implications this can have for has changed since then. There So, how can we use a knowledge
our returns. The final question is a quiet revolution of financial of behavioural finance to create
to consider is how we should excellence emerging within the great results? What does
address this. UK. New advice firms and new behavioural finance tell us about
The important thing to bear advisers have realised the immense building up trusting relationships
in mind is that the biases of power of financial planning done and the power of planning together?
behavioural finance aren’t ‘problems’ well. Financial planning carried out How can we use this insight to drive
that we can ‘solve’. They are correctly can help you achieve your you towards your lifestyle goals?
natural human behaviours that are dreams and focuses as much on Here are some of the opportunities I
apparent in many walks of life. We the goals of the individual as it does think are waiting for us.
just need to learn to be aware of on the bottom line of the balance
them and work with them. After all, sheet. Great advisers are dealing Raising awareness
we are all only human. with the psychology and emotional A knowledge of behavioural
This, I think, is why behavioural aspects of financial planning, rather finance should be an addition to
finance is so exciting. It recognises than focusing on the money itself. traditional investment theory, not
us all – clients, advisers, investors There is a huge opportunity here to a replacement. Growing numbers
– as humans. At First Wealth, this build on this success. of advisers are beginning to see
intelligent, people-focused approach The best financial planning is its benefits and we need to spend
is what our business is built on. always objective; we have a duty to time with clients, help to identify
We spend time getting to know tell clients what they need to hear, the individual biases that affect
our clients and understanding who not what they want to hear. As we them, how this will impact their
they are, what makes them tick look to the future of our profession, decisions and flag up the warning
and where they want to get to. The it’s down to us to educate and signs to look out for. I look forward
reason we believe in behavioural reassure investors that we have to bringing my clients along on the
finance is because it will help us to their best interests at heart. For us journey with me as we raise the

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F I R S T W E A LT H

profile of behavioural finance and should focus on: organisation; together. This approach is as
educate people as to what it is and accountability; objectivity; pro- useful for keeping advisers in check
exactly how it can help. Making this activity; education; and partnership. and focused on the long-term goals
a part of the on-boarding process I recently wrote about his thinking as it is for reminding clients of
with new clients is a great place and how it can help us in creating their ambitions.
to start. The advisers who commit client experiences that will
to taking it up, embed it in their strengthen and nourish the adviser- Adapting the style of
working practices and educate client relationship. reporting to the length
their clients of the tangible benefits of the investment cycle
are the ones most likely to see it Creating a contract While the best general advice about
bring success. Once a client has become familiar investing is not to tinker with the
with the potential pitfalls of letting portfolio and let the markets do
Designing the right emotional behaviour influence their their work over the long term, it
client experiences investment decisions, advisers is still important as advisers that
One of the ways to make can start to work out how to we monitor the progress of the
behavioural finance relevant is to address this for the good of their investments on a regular basis. As
promote how it can have a real and financial plans. With a knowledge of part of our service to clients, once
positive effect on people’s lives. By behavioural biases, the clients could we have structured their portfolio
designing the right experiences, sit down with the adviser and draw and agreed on an investment plan
informed by the insights of up a contract of their relationship, we will meet with them on an agreed
behavioural finance, we can help our highlighting the potential biases schedule to report back on how
clients make consistently and committing to avoiding them their investments have performed in
great decisions. in future. If and when clients and the intervening period.
US financial adviser, Mitch advisers come to a point in their However, if a client has recently
Anthony says that successful long- relationship where the adviser put in place a 20-year investment
term relationships succeed when we feels the client is about to make a plan for their retirement, is it
concentrate on how we make our decision which isn’t in their best or appropriate or necessary to meet
clients feel. He put together a list of long-term interests, they can revisit with them every six months to
six key concepts that he believes the contract to remind themselves assess progress and growth?
financial planners and clients of the agreement they made This could encourage short-term

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 PA R T 1 0

alterations to the portfolio which to put a long-term plan in place and However, if at the beginning of
may have a damaging effect on to allow the portfolio to do its work the relationship we had structured
returns. Perhaps in the earlier years over time. However, nowadays, 24- their portfolio in the knowledge
of a long-term cycle, the focus hour news and the huge availability that in an environment of mass
should be almost entirely forward- of information has made investors availability of information the
looking, towards the ideal future more hands-on and keen to tweak client is likely to want to react to
lifestyle: ensuring they’re spending and amend their portfolio in the higher risk options, could we have
as they should be, that their lifestyle light of every short-term change in mitigated this? It would mean
goals or current situation haven’t the investing climate. Our analysis putting together a portfolio with
changed, and that they are still on of behavioural biases will help to investments of lower risk which are
track to achieve their ambitions. identify those clients who have less likely to cause short-term panic
This would be a healthier approach more composure in times of market or knee-jerk reactions. The goal is
than looking back and obsessing stress, and those who are likely to that their portfolio remains longer
unnecessarily and unhelpfully on make bad decisions under duress. invested in the market. There
short-term returns when there’s An adviser will need to make a will be ups and downs but the
still a long way yet for the judgment call about the type of benefits of compounding over
investment to go. portfolio that is best suited to time will outweigh the blips, leading
each client. to a healthier return at the end of
Constructing a For example, in reaction to the cycle.
portfolio according to the UK’s upcoming exit from the
behavioural psychology European Union, a client may ask to
With an understanding that remove some risk from the portfolio
investors can sometimes behave in anticipation of this unknown
in ways that might be at odds with quantity. We would advise against
their long-term investing success, knee-jerk reaction, and reassure
we could explore the question of them that events like Brexit have
whether we should structure a already been factored in and can be
client’s portfolio accordingly. We absorbed by the portfolio with little
know that the approach that is most or no change to the plan, but the
likely to result in investing success is client may still insist.

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<<< INDEX

An exciting future
An understanding of behavioural finance can gives us the potential to supercharge the
change our approach to investing and points to power of financial planning to help you achieve
an exciting future for us all. It’s an area which is your dreams.
still in its relative infancy and I’m confident that I hope you’ve enjoyed reading this series as
there’s so much more to come. much as I have enjoyed writing it. If you would
Our aim is to help you target your ambitions like to discuss how a knowledge of behavioural
and create your ideal financial lifestyle. finance can help you achieve your financial
Harnessing the insights of behavioural finance lifestyle plans, please get in touch >

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 F I R S T W E A LT H

020 7467 2700 | hello@firstwealth.co.uk

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