August 1, 2018

For constant success, you must change with the times

This week we are going to examine what is known as Status quo bias.

According to Michael M. Pompian, author of Behavioral Finance and Wealth Management, “Simply put, Status quo bias, a term coined by William Samuelson and Richard Zeckhauser in 1988, is an emotional bias that predisposes people facing an array of choice options to elect whatever option ratifies or extends the existing condition (i.e., the “status quo”) in lieu of alternative options that might bring about change. In other words, status quo bias operates in people who prefer for things to stay relatively the same.”

So how can Status quo bias impact investors? Pompian list the following four mistakes investors can make with this bias.

  1. Status quo bias can cause investors, by taking no action, to hold investments inappropriate to their own risk/return profiles. This can mean that investors take excessive risks or invest too conservatively.
  2. Status quo bias can combine with loss aversion bias. In this scenario, an investor facing an opportunity to reallocate or alter an investment position may choose, instead, to maintain the status quo because the status quo offers the investor a lower probability of realizing a loss. This will be true even if, in the long run, the investor could achieve a higher return by electing an alternative path.
  3. Status quo bias causes investors to hold securities with which they feel familiar or of which they are emotionally fond. This behavior can compromise financial goals, however, because a subjective comfort level with a security may not justify holding onto it despite poor performance.
  4. Status quo bias can cause investors to hold securities, either inherited or purchased, because of an aversion to transaction costs associated with selling. This behavior can be hazardous to one's wealth because a commission or a tax is frequently a small price to pay for exiting a poorly performing investment or for properly allocating a portfolio.

Let us help you eliminate this bias.  Professional advisors with disciplined systems of investing tailored specifically to your investment goals will allow you to overcome many of the obstacles inherent in our very nature.  At DWAM, we can help.

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