Battling Behavioral Bias in Investing
Welcome back! We’re continuing our discussion of BIAS – the decision-making shortcuts our brains take to navigate the myriad decisions we have to make each day. Our last blog, Behavioral Bias in Investing: A Primer, defined the most common biases we see show up in investment decision-making. This blog focuses on pragmatic actions you can take to minimize the impact of behavioral bias on your decisions whether you are an analyst, portfolio manager or chief investment officer.
While the techniques described below are all evidenced-based best practices drawn from neuro and behavioral science research and customized for an investment environment, figuring out which strategies to use as part of your process is tricky. The range and diversity of techniques can be overwhelming!
Making good choices for you or your team requires both a high degree of self-awareness as well as an understanding of the biases your unique blend of risk appetite, strengths and stress behaviors create. You want to be able to map your own behavioral tendencies (or those of your team) to the strategies most likely to address your patterns of behavior. Crescente Advisors is skilled at helping investors and investment teams do just that.
Strategies for Reducing Bias
The strategies outlined below can be used by anyone but can be particular useful to investors working more independently (such as central research analysts). I encourage you to reach out to me if you’d like to discuss strategies you might adopt with your team. Cscordato@CrescenteAdvisors.com.
Analysis of Competing Hypotheses (ACH)
Testing differing hypotheses versus the available evidence. Essentially, each of the hypotheses competes with each other rather than having their plausibility evaluated independently. Steps:
Generate a minimum of three competing hypotheses and put together relevant evidence
Identify inconsistencies between the evidence and the hypotheses and discard that don’t prove out
Compile further data to fill in the gaps realized and determine the which hypothesis “wins”
Postmortems (also known as Decision Audits)
Systematically revisiting decisions after they have been made with a goal of identifying any lessons learned. Questions to ask might include:
What assumptions did I make?
Where did they hold true?
Where were they “off”?
What did I miss?
Why did I miss them?
What could I do differently next time?
Identify Assumptions
Creating a discipline in which you write out the implicit assumptions underlying your investment thesis. Be sure to consider conditions under which they may not be true
Starting from Scratch
Reassessing your ratings once a year from with a blank slate forcing yourself to look at the security as if it were not yet rated.
“What Would it Take to Sell?”
Identifying key factors that need to be/remain in place for you to continue to feel the same way about the security before you put a rating on it. Write them down. Periodically revisit this document, reassess and act accordingly
Conclusion
Remember, this is not a one size fits all exercise. Creating a bespoke plan customized to your personality, strengths and risk tendencies enables you to work efficiently and optimizes for the best outcome. These are just a sampling of some of the techniques individuals can use. There are a broad range of strategies and techniques to debias TEAM decision-making. Feel free to reach out to discuss with me.
For more information, contact Christine at CScordato@CrescenteAdvisors.com.
