Investor Biases: Be Aware To Boost Returns

Nov. 13, 2017 1:00 PM ETAAPL, AMGN, AMZN, BIDU, DIA, DLTR, EXAS, META, GOOGL, INCY, IWM, MSFT, NFLX, BKNG, QQQ, REGN, SPY28 Comments

Summary

  • We can be irrational investors and have to be aware of our biases.
  • Investing biases can cost us significant returns over time.
  • Group thinking, loss aversion, and overconfidence are few of the prominent biases we possess.
  • Systematic investing diminishes the bias-related underperformance evident in active management.
  • Biases can be hard to eliminate but can be managed to improve investment performance.

GraycellAdvisors.com ~ Bull and Bear
Recently, we wrote about how Systematic Investing Works Great and on the growing body of research that provides evidence regarding the superiority of quantitative models and algorithms in decision-making versus relying on the expert judgment of active managers. In the article we compared two Graycell quantitative portfolios with index benchmarks: (a) the Graycell S&P Quant Portfolio with the S&P 500 index and (b) the Graycell Small Cap Quant Portfolio with the Russell 2000 index, demonstrating the significant risk-adjusted excess returns of quantitative portfolios over benchmark indexes.

One of the key reasons that quantitative portfolios are well-positioned to outperform active management, in which money managers or individual investors buy and sell positions based on their company analysis, is the mitigation of behavioral biases.

What are Biases?

Behavioral biases are our tendencies to react in a certain way. Such tendencies are embedded in our thinking and influence decision-making to a significant extent. These biases are the mental shortcuts, important for speeding up our thinking and reducing cognitive load, and oftentimes our biases save us time and energy.

Along with the natural cognitive biases, we are also influenced by the pool of emotions and experiences accumulated over our lifetime, which create certain proclivities in our thinking. We lean on these preferences to aid in our decisions and judgments.

All these cognitive and emotional tendencies are collectively referred to as behavioral biases. These are the subjective elements of our decision-making, the ones we possess by default.

Biases and Investing

Making rational decisions was not really a priority on the plains of Africa as the human species evolved a few million years ago. But surviving the day from the lions and other threats was a priority, and instincts and biases became imprinted on our mind, in place of rational analysis, to boost our survival chances.

This article was written by

Tarun Chandra, CFA profile picture
4.68K Followers
A healthcare growth portfolio with a record of consistently strong returns

I have worked as an Analyst on both the Buy (Asset Management) and Sell (Investment Brokerage) sides, as well as in Strategy and Finance roles for technology services companies. For many years, I have been publishing risk-adjusted, return-driven quantitative model portfolios.


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