Lessons in behavioral finance: Anchoring bias
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OMAR AGUILAR: Hi, my name is Omar Aguilar. I’m the Chief Executive Officer for Schwab Asset Management.
Over the last several months, financial markets have experienced elevated levels of volatility across major asset classes like equities, bonds, currencies, and commodities. Around the world, inflation has risen sharply, and in response, global central banks are raising interest rates aggressively in order to stabilize prices, slow down economic activity, and, ultimately, to get inflation under control. Of course, these actions have raised a lot of questions about the impact of interest rates and the strength of our economy.
Well, we’re here to help. With behavioral finance concepts, we hope to provide you with some explanation, some context, and some guidance on how to navigate these complex markets.
Lately, some investors have compared the current environment to the one we had in the ‘70s and ‘80s. Back then, the Federal Reserve under Paul Volcker raised interest rates aggressively in order to control double-digit inflation that ultimately led into a US recession.
If you or your clients have made these comparisons, these may be signs of anchoring bias. Anchoring bias is a cognitive bias that causes us to rely heavily on the first piece of information we have about a topic, instead of looking at the whole picture objectively. The anchor or reference point could be the result of a research paper, our own first experience with the topic, or a historical event like the recession of the ‘70s and ‘80s. So what can you do about it?
Number one, remember that every economic cycle is different. Economic activity is driven by factors like technology, demographics, and social dynamics. If you think about it, most of what drives our economy today did not exist back in the ‘70s and ‘80s, like electric vehicles or the internet.
Number two, evaluate your strategy under different scenarios. Test your portfolio on their recession, self-landing, expansion, stagflation, and evaluate the range of outcomes that you get from the exercise to make sure you’re comfortable with the level of risk that you have in your portfolio.
Number three, focus on your long-term investment objectives. Use short-term volatility to apply a systematic and disciplined approach to rebalance your portfolio to align it with your long-term investment objectives.
One final point, if you’re looking for ways to identify and treat behavioral biases among your clients, consider visiting our behavioral finance framework called Biagnostics, where you will find tools that will help you with biases like anchoring.
Thanks for listening.
Are past economic events haunting your clients’ concerns about inflation, rising interest rates, and the potential for a U.S. recession? If so, anchoring bias may be to blame. Omar Aguilar has three strategies to help advisors address this cognitive bias and realign your clients’ focus.
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