FA Center: The odd trick that helps investors avoid damaging habits: nagging

John Goodman and Roseanne Barr in “Roseanne.”

CHAPEL HILL, N.C. (MarketWatch) — Financial advisers, stop bemoaning your clients’ much-vaunted tendencies to behave irrationally. There are ways you can help them change. And they’re surprisingly simple and easy.

That is the encouraging conclusion to emerge from a new study, conducted by researchers at Italy’s University of Calabria, that began circulating last month in academia. They found that investors significantly increased returns upon being reminded of the all-too-human tendency to behave irrationally.

That’s all it took.

Not a detailed treatise on the myriad ways in which we can let biases affect our decision-making. Just a one-sentence reminder, which read: “We take this opportunity to remind you that individuals are affected by some behavioral biases when trading and these biases may reduce the performance of their portfolio.”

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Investors in the study who received that one-sentence reminder did 1.8 percentage points better than those who did not over a five-week period. Though that may not seem like much, the researchers argue that it is, in fact, quite impressive for such a short period — and significant according to traditional statistical standards.

The behavioral biases the researchers referred to are widely known. Princeton psychology professor Daniel Kahmenann won the Nobel Prize in Economics in 2002 for his groundbreaking work with the late Amos Tvsersky in documenting and classifying such biases, and social scientists have today identified hundreds of them.

Among the biases that have the largest effect on investor behavior, according to behavioral economists such as Richard Thaler, the University of Chicago economics professor who just won this year’s Nobel Prize in economics:

• Myopic loss aversion: This is the combination of two different biases — a tendency to focus on short-term performance (the myopia) and a greater sensitivity to losses than to gains (the loss aversion).

• Reference point thinking: Investors reach different conclusions about a stock’s prospects depending on the price at which they first bought it. Those who hold the stock at a loss tend to be unwilling to sell it, regardless of how awful its future appears to be, since such a sale would lock in their loss.

• Home bias: Investors tend to overweight the stocks of companies based in their home country and underweight foreign firms.

• Overreaction: Investors tend to exaggerate new information, believing that positive news is much more positive than it really is, and vice versa.

• Overconfidence: Investors exaggerate their abilities to time the market and pick stocks, interpreting luck as evidence of skill.

The researchers found that mere knowledge of these and other biases is not sufficient to overcome them. That’s because all the investors in their study — both those who received the reminder about behavioral biases and those who did not — received the same information about the existence and impact of these biases before the experiment.

Read: When dumb things happen to smart investors

The finding has to do with the distinction between knowing and doing. A good comparison is the “knowledge” that diet and exercise have a big effect on overall health: Virtually everyone “knows” the effect to be huge, but that knowledge doesn’t stop us from engaging in unhealthy behaviors.

Many therapists have found that gentle reminders — what some call “nudges” — can make a big difference in translating knowledge into action.

The reminder that the researchers sent to the group of traders was just such a “nudge.” And it was only this “nudged” group that experienced the improved performance.

The investment implication is that financial advisers should find ways of being in regular contact with their clients to remind them of the self-destructive behaviors in which they otherwise might be engaging—to nudge, them, in other words.

To be sure, this is easier said than done, since periodic contacts can appear artificial and forced. But perhaps this awkwardness at least partially can be overcome by sharing with clients this new study. Improved performance can trump a lot of uneasiness.

And the reminders need not be lengthy to be effective. Short and sweet seems to do the trick.

You’re invited: MarketWatch is hosting a free panel discussion on international investing on Tuesday, Oct. 24, in Los Angeles. RSVP required, continuing education credit available. Learn more and RSVP.

This story was first published on Oct. 10, 2017.

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com.

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