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Financial Planning Is your client prey to hindsight bias?

Is your client prey to hindsight bias?

Making an investment decision based on past experience can cause financial problems. Find out how to deal with clients with cognitive bias.
Team Cafemutual May 30, 2018

I knew India would win the match.

I knew it would rain today.

I knew I would ace the exam.

The situation may be different each time, but we hear ourselves say it over and over again: “I knew it all along.” The problem is that too often we didn’t actually know it all along; we only feel as though we did. This behavioural trait is called ‘hindsight bias’ or ‘know-it-all-along effect.’

Generally, after an event has occurred, such people tend to believe that the onset of that event was predictable whereas in fact, it could not have been predicted reasonably. They tend to find causal connections where none exist and this can affect how we interpret not only a past event, but future ones as well.

This indicates that usually by overestimating the accuracy of past events, investors become over confident and make decisions and design portfolios with too little consideration of their own risk or goals. This leads to poor results.

Hindsight bias can also affect your relationship with your client; if your client believes you should have been able to accurately forecast market performance, they could lose confidence in your abilities and advice if things do not turn out as desired. Very often, advisors receive calls from their clients who suffer from hindsight bias and take decisions by connecting the past and future. This in turn has a major impact on their investments.

We spoke to a few IFAs to understand how they deal with such hindsight bias.

Suresh Sadagopan, of Ladders7 Financial Advisories, says he generally draws the client’s attention to the decisions which they have taken in the past. “Life is never linear or predictable. Only after a certain period, you will know if the decision you took was good or not. With hindsight bias, clients generally think it’s simple to decide, but it is not,” he says.

Suresh likes to quote the example of gold funds to explain matters. In 2010-11 gold was doing exceptionally well and people started investing in gold funds. Now the decision does not look great as they just got 3-4% return in gold. “I generally go back and speak to clients about their decisions which they have taken and speak about both the positive and negative outcomes of the same,” he added.

Amit Bivalkar, of Sapient Wealth Advisors, believes clients should focus on tweaking their own portfolios. He says, “Clients start believing that they can avoid scams based on their past experience, which is not true. So, adjusting your investment behaviour to your time horizon and maintaining asset allocation are the key factors, which I explain to my clients to deal with hindsight bias.”

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