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Anchoring & Recency Bias, Overconfidence and more!

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In this last post about investment biases, I cover the anchoring and recency bias and the overconfidence and self-attribution bias. I also share my tips for overcoming these biases so that they don’t lead to poor investment decisions. If you missed the posts covering the other biases, here are some links:

Recognize and Overcome your Investment Biases

How Hindsight and Loss Aversion Hurt your Investment Decisions

Anchoring and recency bias

The anchoring bias occurs when we rely too heavily on the first piece of information we encounter (the “anchor”) when making decisions.

For example, holding on to shares of Algonquin (AQN) because it was once worth $22 a share; thinking the stock market is going to collapse and never come back by citing Japan; or calling for stagflation because you recall the 70s. Ironically, we had legions of “experts” calling a stagflation period a few years ago. They’re pretty quiet now.

If you look at your portfolio while constantly thinking about the 70s, you might sell a good part of your stocks and buy gold, convinced the yellow metal will make another 900% run. You’ll ignore the particular context in which events occurred in the 70s, which is far from the one we have now; you’ll focus on the “high probability” of seeing gold prices continue to go up. Since gold is on its way to doubling its value in 5 years, why not it at around $7,000 in 5 more years?

While looking at what happened 10 or 20 years ago to draw conclusions will lead you in the wrong direction, so will giving undue weight to recent events or trends. This is called the recency bias. Since there is a limit to the amount of information our brain can properly process, remembering the last important events is often enough to shape an opinion.

Since the economy is always evolving, we must consider recent history. After all, “cloud services” was not in our language back in 1999, it wasn’t even a thing! However, ignoring how events or crises similar to current ones unfolded in the past could also cost you a lot. When you look at the big picture, history does tend to repeat itself almost indefinitely.

Dangerous things happen when you combine the with anchoring. With anchoring, you focus on an event believing the same circumstances are happening again. The hindsight bias, which comes from a strong desire to predict the future, will reinforce you anchored belief and push you to take action accordingly.

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Overcome the anchoring & recency bias

When someone asks me about any specific stock, I say to not rate it as a good or a bad investment based on its recent stock performance. When a stock is up, it’s not necessarily a good investment for your portfolio and vice-versa. What matters is why a stock is doing well (or not) on the market. You won’t find the reasons in the media, but rather in the process of reconciling your investment thesis with financial metrics, like those of the dividend triangle (revenue, EPS, and dividend growth).

Will AQN ever trade back to $22? Ask yourself what the narrative was back then. AQN had an aggressive growth-by-acquisition strategy using cheap debt to buy utility assets. It converted those utility assets into renewable energy providers and kept on growing. Today, AQN is selling its renewable assets and has stopped growing by acquisitions. It wants to strengthen its balance sheet and pay off its expensive debt. That is far from the 2021 narrative. To get back to $22, AQN has to write a new growth narrative from scratch. Good luck.

Overconfidence and self-attribution bias

Since we choose to manage our portfolios ourselves, I’d say overconfidence is probably a bias we’re all guilty of. This is the belief that we have an edge over others, a unique ability to understand the market a bit better than everybody else. We don’t have to think we are geniuses; just believe we’re better than the average bear.

I plead guilty to this! Logically, investing with conviction could lead to overconfidence!

When I buy shares of Alimentation Couche-Tard (ATD.TO), I believe it’s the best convenience store operator on the planet. I think its assets are better than gold and that its stock price will go up. The fact that ATD.TO is now in my portfolio makes me think it’s getting better every day. I picked that stock for a reason, right?

The self-attribution bias is slightly different.  This is when all success is attributed to our magnificent ability to read the market while all failures are caused by external—and impossible to predict—factors. This protects our ego, enabling us to feel confident again while denying any flaws. This could be highly counterproductive if you can’t own your decisions.

For example, I could say that I went through the 2020 market crash and the strong recovery with great success. I might believe that my rock-solid strategy and my ability to select the right stocks are the only reasons explaining that success. This is only partially right; following a rock-solid investing strategy helps, but it would be dishonest to ignore that about 25% of my portfolio was in tech stocks. This sector thrived during the lockdown and helped my portfolio recover a lot faster than the market. Did I plan to have a quarter of my portfolio invested in tech stocks because it would be beneficial in case of a global lockdown? Absolutely not. We must remain humble when looking at our portfolio returns.

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Overcome the overconfidence and self-attribution bias

When my portfolios increase in value, I usually stay humble and thank the quality of my investing process. I “trust the process”. When my portfolio goes down, I acknowledge my potential losses and try to find where I went wrong. After reviewing my investment thesis for each holding and ensuring it’s backed by a robust dividend triangle, I go back to… “trust the process”.

I reduce the overconfidence and self-attribution bias by making everything about the process and not about me. My goal is to keep a high level of conviction since it prevents me from panicking and selling whenever the market goes down.

The post Anchoring & Recency Bias, Overconfidence and more! appeared first on Dividend Monk.


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