So why study behavioural science? Although it is not possible to defeat biases (you can really only work with them), there are things you can do in the moment, and ahead of time, to help keep your clients’ biases from derailing their financial plans.

“Before volatility hits, clients may benefit from understanding the psychology behind their emotions. Research finds that educating people about the biases we all face, as investors and human beings, helps them recognize the impact of biases in their own decisions,” writes Morningstar Inc. behavioural researcher, Samantha Lamas, and Morningstar’s head of behavioural science, Stephen Wendel in the firm’s recent report, A Behavioral Guide to Market Volatility: How Behavioral Science Can Help Advisors During Market Turmoil. “This can mean discussing behavioural concepts with your client and explaining prevalent biases, such as recency bias, herding behaviour, and action bias. A ‘we all have this’ approach avoids judgment and condemnation to help investors and advisors alike to recognize the challenges we all face.”

Some of the biases covered in the report include recency bias, overconfidence bias, herding bias, myopic loss aversion (with more frequent information updates people tend to react more strongly to potential losses), loss aversion, action bias, and confirmation bias.

Note: Much of this education needs to happen ahead of time, they add. “If you try to introduce rules to action when there is volatility and your client is in a state of panic, it's not going to go well,” Wendel told those gathered for a behavioural science roundtable at a recent virtual Morningstar investment conference. “Your client is not going to react positively.” Instead, he suggests introducing these concepts during a relatively calm period when volatility is not foremost in your client’s thoughts.

  • Recency bias: This is the tendency to overweight current or recent events. Clients see markets going down and assume they will continue to decline. To counter this, the experts suggest advisors counter vivid memories with equally vivid descriptions about client goals and life outcomes.
  • Overconfidence bias: The tendency to believe that we are better or will do better than the average person. “We all tend to be unrealistically optimistic about our chances of success,” Morningstar researchers write. “This can result in investors making rash choices and believing that, when push comes to shove, they will be spared the pain others will experience.”
  • Herding bias: The tendency to give too much weight to what other people are doing in the moment.
  • Myopic loss aversion: Increased information, too many updates, can make people react more strongly to losses and potential losses. Interestingly, investment professionals are not immune. Morningstar says a study of experienced financial planners found that traders who were more exposed to price changes were more likely to repeatedly adjust their risk exposures, undermining overall performance.
  • Loss aversion: Investors tend to place undo focus on losses over gains. “Specifically, a 10 per cent portfolio loss feels a lot worse than a 10 per cent gain for many investors because we are risk-averse,” Wendel and Lamas write in their behavioural guide. “Experiencing a loss generally feels twice as bad as gaining the same amount.”
  • Action bias: This is the desire to do something, anything, in the face of market volatility. (It can feel tremendously unnatural to do nothing, even if doing nothing is in fact the best course of action.)
  • Confirmation bias: The tendency to seek out and pay more attention to information that already supports our existing opinions. “Even when we’re doing our research, our mind just feels more comfortable following information and understanding information that already supports our ideas,” Lamas says. “This can be especially dangerous when it comes to our finances.” To combat confirmation bias, she suggests getting clients to explain an opposite viewpoint.
  • Illusion of control: “We find this very surprising,” says Kelly Peters, co-founder and CEO of consulting firm BEworks at a recent Manulife Investment Management webinar on the topic. “Individual investors who generally did not have very high-level investment knowledge would still think they have the ability to do a better job than their financial advisor. This is another bias that we need to make sure that we are watching out for.”

BEworks co-founder, professor, bestselling author of several books on irrationality, and the firm’s chief behavioural scientist, Dan Ariely says a few pointed questions may be needed to help clients get past the belief that they are smarter than the market. If clients believe markets are going to go down, for example, he suggests asking them if they know something that other people do not. “I would explore that,” he says. “What exactly do you know? What insider information do you have that other people do not?”

Finally, Ariely says advisors should also understand that saving is a long-term effort that can be inherently unfulfilling. “Make it more fulfilling,” he says. “You want the person to feel that they have done a good job.”