Behavioural economics 101 – Tackling the biases that impact our property and investment decisions (Ep.134)

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In this week’s episode, Dave, Cate and Pete take you through:

  • How does bias impact our financial decisions? Behavioural biases are defined as unconscious beliefs that influence our decisions. In the field of finance, behavioural bias is a study that focuses on psychological factors that influence the decisions of investors. There are some 180 recognised biases and unfortunately we can’t unpack them all, however the trio have picked the top 6 biases to investigate.
  • Bias 1 – Mental accounting. Mental accounting refers to the concept where people treat money differently depending on where it came from and what we think it should be used for. The trio discuss the varying ways that this bias can manifest in our financial lives.
  • Bias 2 – Loss aversion. This bias refers to a higher sensitivity to incurring losses than making gains. It impacts investors when the fear of loss is disproportionate to the risk itself, and fear stalls their ability to make a decision. The trio delve into how this bias can hamper investors and how to mitigate the influence of this bias if you are conservative in nature.   
  • Bias 3 – Overconfidence bias. This bias is the tendency to see ourselves as better than we are and is common in investing. Overconfident investors generally do not manage and control risk properly; they engage in active investing, (instead of passive investing) and adopt a DIY philosophy. In the property space, we see it most commonly when people assume they can carry out a major renovation or development, when ordinarily this activity should be carried out by a skilled/experienced renovator or builder.
  • Bias 4 – Anchoring bias. Anchoring is a phenomenon where someone values an initial piece of information too much to make subsequent judgments. In investing, this can influence decision-making regarding a security, such as when to sell or buy an investment. The trio discuss how this bias can come about: either through a negative or positive personal experience, (or third party experience). Anchoring bias can also be passed on through generations. The trio discuss how you can effectively tackle this bias and carry out your own assessments.
  • Bias 5 – Familiarity bias. This bias is characterised by investors preferring familiar investments, despite the advantages of diversification.  This can manifest itself in people wanting to purchase investments in their own state, region, city or suburb. To counteract this bias, you need to be prepared to do comprehensive assessments to look at a broad array of options.
  • Bias 6 – Herd behaviour bias. Herd behaviour occurs when investors follow others rather than making their own decisions based on financial data. People follow the herd because it feels safer, which is the opposite of contrarian investing. The trio discuss examples of herd behaviour in property.
  • How can buyers think more rationally and independently? The trio share their insights on how to make informed and successful property decisions, and specifically; to mitigate any biases that may be in play.

Resources

Show notes

  • The feedback that we received 
  • It’s not a genuine discussion when asking Cate whether it’s a good time to buy. Her business suffers if people don’t buy so she would never say it’s a bad time to buy.  
  • The pas performance anchoring bias is all pervasive. 40 years of population growth, interest rates trending to nothing and government settings have had a huge upward impact on property prices. The hosts have built their businesses and identities in this property fertile macro environment. Their ability to pick ‘A grade’ property meant their gains far outpaced the market.  
  • So, did Cate respond to Pete’s question in an unbiased fashion? 
  • No, it was biased. It was really good food for thought piece of feedback. I don’t like influencing someone to purchasing within the location that I operate within. 
  • An example of trying to avoid bias, if someone is looking to diversify or if I’m not a specialist in the market the person wants to purchase. 
  • Familiarity with the market and a deep knowledge of the high-performing areas in Vic 
  • Cate’s own success with personal investments in Vic – had a good run, made some mistakes, but overall it’s been a success. 
  • Self-interest: not intended, but a natural intent to see Victoria as a solid option for investors. 
  • Science has proven we all carry 188 biases. How do they come into play in our profession and day to day life? 
  • Freakonomics, book by Steven D Levitt, Stephen J Dubner – unusual areas where bias has had an impact in medicine, teaching and sport. 
  • Pete, if you look introspectively, where do you feel you could carry bias on our show? 
  • Pete – Character properties and period properties – generally this property would be worth more than a non-character property. How much more depends on your bias. 
  • Pete – Adelaide is a good place to invest – if you don’t like the really big downs in a property market. It is more of a steady performer. 
  • Pete – capital gains over cash flow, but this is based on research. 
  • Dave – Property Plans do not have location bias – but I think I have a level of bias to Melbourne because I’ve lived here and it’s where I’m based. You try to be conscious of that when thinking about decisions and recommendations. But that doesn’t mean that it would be entirely removed. 
  • Dave – I certainly barrack for the market to slow down once it’s been on an upward run for too long. I don’t want it to correct significantly, have a big fall that will impact a lot of people and cause greater problems for the economy. 
  • What is behavioural bias in finance 
  • According to one of our sourced articles: behavioural biases are unconscious beliefs that influence our decisions. Behavioural finance is a field of study that focuses on psychological factors that influence investors’ decisions 
  • We can’t cover all of the modern research of behavioural economics, but we’ll touch on a few components of it. 
  • We’ve picked 6 biases to unpack.  
  • Bias 1 – Mental accounting 
  • Mental accounting refers to the concept where people treat money differently depending on where it came from and what we think it should be used for. 
  • We treat money differently depending on whether we’ve earned it/been gifted it, or pending it’s magnitude, we may be more/less prepared to spend it on fun things. 
  • Examples – when money is gifted rather than when it is earnt, like giving your child pocket money. 
  • We will happily spend a smaller incentive, ie. $1,000 economic stimulus, but more prepared to save a more significant incentive. 
  • Our children: different willingness to spend their own pocket money as opposed to gifted money. 
  • Buckets – rainy day account, but mounting debt on your credit card which is costing a lot of money, but people just feel nice having that money there and seeing it grow, even if paying down the debt is the smartest thing to do. 
  • Bias 2 – Loss aversion 
  • A higher sensitivity to incurring losses than making gains. 
  • Investors can be impacted when the fear of loss is disproportionate and slows them down – procrastinate, overthinking, analysis paralysis, parking money in low returns. 
  • Robert R. Johnson, professor of finance at Creighton University’s Heider College of Business argues that loss aversion can cost us money. “The biggest financial mistake people make is taking too little risk, not too much risk,” he says. Loss aversion helps explain why: Losses hurt more than gains are savoured. 
  • More money is lost through not making financial investment decisions. 
  • On average, stocks and property market is higher than CPI, it’s higher than interest in a bank account. 
  • Having a plan is a mitigant – people want to better understand their goals, their financial situation, how to manage risk, how they can optimise returns and make a decision with confidence. 
  • Bias 3 – Overconfidence bias 
  • According to business insider – Overconfidence bias is the tendency to see ourselves as better than we are. It’s common in investing. A 2020 review published in the International Journal of Management found that overconfident individual investors generally do not manage and control risk properly. 
  • This hinges on people who adopt a DIY philosophy where they are not aware of what they don’t know. 
  • One of the best mitigants – consult a professional and get a gut check on your investing strategy to solicit alternative perspectives. 
  • “And consider sticking to passive investing rather than trying to time the markets. After all, active traders tend to do worse than those who buy and hold.” 
  • We see people trying to get faster return in property, who actively invest rather than passively invest. 
  • We’re seeing some of that right now, people are exuberant, paying over market value. When the tide goes out and the market slows down, some people can be left high and dry. 
  • When people assume that they can do something that ordinarily a highly skilled person should be doing – significant renovations or development for example. 
  • Bias 4 – Anchoring bias 
  • Anchoring is a phenomenon where someone values an initial piece of information too much to make subsequent judgments. In investing, this can influence decision-making regarding a security, such as when to sell or buy an investment. 
  • It could be a positive or negative experience that taints someone’s opinion about moving forward. Could also be a friend or experience of a loved one. 
  • Our parents and grandparents – debt aversion – this is anchoring bias at its best. 
  • One major life experience – you lose a lot of money in shares, or you live through a great recession and lose your business or your house. 
  • These biases can get passed down through the generations as well. 
  • It can also be a positive experience that is misread as well. 
  • Business insider’s tip for mitigating this risk: Be open to new information – even if it doesn’t necessarily align with what you’ve initially learned. 
  • Pete – very first development took a long time to sell (it was a battle axe development) and decided I would never do one again. But because it was a bad experience, I’ve decided not to do it again.
  • Bias 5 – Familiarity bias
  • What is it – “Despite obvious gains from diversification, investors prefer “familiar” investments of their own country, region, state, or company. In a study, Columbia Business School professor Gur Huberman found that in 49 out of 50 states, investors are more likely to hold shares of their local Regional Bell Operating Company (RBOC)—regional telephone companies—than of any other RBOC. Investors also prefer domestic investments over international investments.
  • Opening our options can create more investment opportunity for us.
  • Be prepared to do comprehensive assessments. Look at a broad array of options.
  • Bias 6 – Herd behaviour bias
  • What it is: Herd behaviour happens when investors follow others rather than making their own decisions based on financial data. If people feel that someone else is doing it, then it must be ok.
  • People follow the herd because it feels safer. This is the opposite of contrarian investing.
  • There’s also the “fear of missing out”
  • Examples of this is include: Bitcoin, waiting for jobkeeper to run dry and for the market to fall, investing in hot spots.
  • How can buyers think more rationally and independently?
  • Being informed, choosing where you source your information from – a broad range, read a lot and ask good questions. Get a recommendation from someone to see someone with an experience.
  • Often, we search for the answers that we want to hear – confirmation bias.
  • What resources do we each try to lean on to give us a better chance?

Gold Nuggets

Peter Koulizos – The Property Professor’s Golden nugget: I think to help eliminate bias, triangulate your information or research is a good thing to do. If you find three independent people saying the same thing, you can be pretty certain that what they’re saying is correct.

Cate Bakos – The Property Buyer’s Golden nugget: I think it’s great for any investor to understand a bit about bias and read what you find online or in books, to find out which you could be most vulnerable. When you understand and have some mitigants in place, you can have a plan to invest successfully.

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