Why action bias is a danger for investors

Why action bias is a danger for investors

Why action bias is a danger for investors

The impulse for soccer goalkeepers to dive left or right when facing a penalty rarely pays off, with statistics suggesting standing still increases the chances of a save.

Nader Hamid, of Holliswealth, Industrial Alliance Securities, believes this scenario is the perfect analogy for action bias; the tendency of investors to respond to short-term events even if their time horizon is long.

Just like a goalkeeper who doesn’t want the “embarrassment” of standing still, an investor is susceptible to being influenced by hype and headlines, and making the wrong move.

Hamid said: “That’s what action bias is; it gives us a temporary sense of control. It’s usually caused by boredom; when you are sitting in the back yard in the summer time, or panic; when you see this newsflash of Facebook down 20%, for example.”

He added that many investors feel they have to do something: do I buy more or sell more?

“More often than not, just like in the soccer world, behavioural finance says that there is a massive outperformance penalty for this active trading and that’s in addition to the cost and tax of doing these transactions.

“What we’ve seen is that advisors are even more prone to action bias. Just like that goalie, there is pressure to give the perception of added value, to make changes and to adjust when staying the course is usually better, especially when you have a long-term strategy.”

Hamid said that the recent Facebook example, which he believes is not a major issue for investors with a 5-10 year plan and a solid investment thesis, perfectly demonstrates the temptation to disrupt your portfolio.

He believes that a true value-added strategy should be three years or more and that if your original thesis remains intact, why change?

He said: “If your investment thesis on Facebook six months to a year ago hasn’t panned out, some of these things take time to materialize and six months is too short of a time to evaluate.

“A lot of investment strategies, whether it’s international, or getting in or out of tech, haven’t materialized and people are looking at whether they should make changes, focusing on that six-month strategy … but usually six-month strategies in business are for putting out fires.”

He added: “Going back to when you did your due diligence on purchasing Facebook, is that thesis still intact? And for most people, and for any stock, that thesis should be a five-year time frame.”

 

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