FAMILIARITY BIAS MEANS STICKING WITH WHAT YOU KNOW – BUT THERE MAY BE A LOT THAT YOU DON’T

Are you a creature of habit? When you visit the grocery store, do you fill your cart with the products and brands you’ve bought for years? The same cheese, the same wine, the same soap. Is that because they’re the best of the options … or because they’re the ones you know best? It can be hard to tell, can’t it?

GET FAMILIAR WITH FAMILIARITY

Do you find yourself placing the same coffee order time and again? Explore how familiarity can mess with your financial future and learn how to outsmart your subconscious.

A familiarity bias is the subconscious tendency to gravitate toward what we know, often without realizing it. It’s why you might place the same coffee order every time without thinking twice, or perhaps why you’ve consistently owned a particular brand of car.

Lots of us go with what we know – and that’s not always a bad thing. However, when it comes to your financial plan, leaning too heavily on what’s familiar can lead to an underdiversified portfolio and gaps in your wealth plan. By trying to play it safe, you could actually be putting yourself and your hard-earned wealth at risk.

FAMILIARITY MIGHT BE PLAYING A ROLE IN SOME OF YOUR DECISIONS IF:

• You often frequent the same places and order the same things.
• You consider yourself loyal to certain brands, whether cars, clothes or toothpaste.
• You gravitate toward products and places that you’ve heard of, perhaps because you’ve seen them in a commercial or heard someone talking about them.

Americans invest nearly 75% of their portfolios in U.S.-based assets – despite the fact that the U.S. accounts for a fraction of global GDP and a little more than 35% of the world’s capital markets. Source: JP Morgan

HOW CAN A FAMILIARITY BIAS DISRUPT YOUR FINANCES?

The trouble with familiarity when it comes to wealth is that it can sway people to make decisions that aren’t aligned with their holistic financial picture. When it comes to investing, this often leads to a lack of diversification in portfolios. For example, if someone is selecting investments based on familiarity, they might be overweighted in domestic securities, or a disproportionate number of their investments could be large, well-known companies or those they’ve worked for. Plus, if an investor chooses a stock solely because of its name, they might not have researched all of its underlying characteristics – like risk.

Just because you like a company as a consumer doesn’t mean it is the best fit for your portfolio. And just as we shouldn’t overestimate what’s familiar, we shouldn’t necessarily underestimate what’s unfamiliar, either. For example, someone might not know much about certain estate planning solutions but that doesn’t mean these specialized vehicles aren’t a good fit in their financial plan. Similarly, an individual may opt for a traditional savings vehicle instead of considering alternative solutions like 529 plans or HSAs*.

WHEN FAMILIARITY FACTORS INTO YOUR FINANCIAL PLAN:

• You might be overweighted in domestic securities, well- known companies, or companies you’ve worked for.
• You may have avoided unfamiliar planning strategies, like insurance, cash management and more, that could provide a more well-rounded financial plan.
• You might risk increased losses by concentrating a large portion of your portfolio in a particular investment, asset class or market segment.
• You may not be considering whether your investments are the best fit for you from a risk-reward perspective.

THE GUARDRAIL

While we all enjoy taking the path more traveled from time to time, that doesn’t mean familiarity needs to get in the way of your long-term financial well-being. Fortunately, there are several steps you can take to help you avoid the potentially negative effects of familiarity in your financial plan.

For starters, seek out objective research in all elements of your wealth strategy. For your investments, this can help you vet a security for its risk level and historical performance. As your advisor, I can not only help provide you with research about individual investments but can also offer guidance and recommendations to help ensure you have a well-balanced portfolio that fits into your larger wealth plan.

Further, we can review your comprehensive financial plan and see where we might incorporate strategies and solutions that may be a good fit for you – including those you might not be familiar with. Using the sophisticated planning software at my disposal, we can monitor your progress and adjust as needed to make sure your financial plan is aligned with your long-term goals.

Put simply, there are many factors to take into consideration when crafting a healthy financial plan. That’s why I’m here to serve as a trusted resource and sounding board, able to provide you with the experienced insight and knowledge you need to address each of your objectives with objectivity.

THINK BEFORE YOU ACT

To help you keep familiarity from overly influencing your financial plan:

• Don’t confuse awareness with understanding or expertise. Rely on objective research.
• Take the time to consider your motivations for selecting certain investments or strategies.
• Don’t rule out an investment or financial strategy because it’s foreign to you.
• Call us or schedule a meeting anytime to receive the objective insight you need to make important decisions surrounding your wealth.

There is no assurance that any investment strategy will be successful.

Diversification does not ensure a profit or protect against a loss. Investing involves risk, and you may incur a profit or loss regardless of strategy selected.

*Alternative Investments involve substantial risks that may be greater than those associated with traditional investments and may be offered only to clients who meet specific suitability requirements, including minimum net worth tests. These risks include but are not limited to: limited or no liquidity, tax considerations, incentive fee structures, speculative investment strategies, and different regulatory and reporting requirements. There is no assurance that any investment will meet its investment objectives or that substantial losses will be avoided.

Whether it’s a sailboat or a security, it’s hard to admit when an investment is no longer paying off - and even harder to accept the loss for what it is and move on. Sometimes, you stand to lose more by not letting go. Explore how loss aversion can expose you to risk and learn how to outsmart your subconscious.

There’s no need to go down with the ship

LOSS AVERSION MAKES IT HARD TO KNOW WHEN TO LET GO IN ORDER TO MOVE FORWARD

Loss aversion. It’s what leads people to hold onto items long past their usefulness and to refuse to part with others until they get what they paid for them. It might sound wise to try avoiding losses, but taking it too far could keep you from realizing your financial goals.

THE PAIN OF LOSS AVERSION

As the name implies, loss aversion is our instinct to not just prefer a gain over a loss, but to prioritize avoiding losses over almost any- thing. It’s the comforting appeal of sticking to the status quo and is often why those who have experienced significant financial loss due to a market crash or recession may be less likely to invest.

Our aversion to loss can be felt across many aspects of our lives – making it difficult to part with everything from threadbare sweaters to underperforming investments. In fact, research has shown that we often believe items we own are worth more than identical items we don’t – simply because we own them.¹

But more than just causing you to miss out on opportunities, loss aversion can actually open you up to unnecessary risk in your financial plan. The fear of loss – which several studies have suggested is twice as powerful, psychologically, as the good feelings generated by gains – is so strong for some that they will make questionable decisions purely to avoid it.²

LOSS AVERSION MIGHT BE PLAYING A ROLE IN SOME OF YOUR DECISIONS IF:

• It’s tough for you to admit when you’re wrong
• You hold on to things with emotional value
• You brood over past mistakes
• You have experienced a significant financial loss;
• Stray from their established financial plan

The average person is willing to risk a potential loss only if they stand to gain at least double that amount. Source: Journal of Experimental Psychology: Vol 144(1), Feb 2015, 7-11

IS FEAR OF LOSS HOLDING YOU BACK?

Money is frequently one of the things people are most afraid of losing, which means loss aversion can become even more influential – and potentially damaging – when it comes to your finances.

A 2007 study conducted by Russell Poldrack, a professor of psychology at Stanford University, monitored participants’ brain activity when presented with potential monetary gains and losses. And while he and his colleagues found that brain activity was heightened by both possibilities, it was markedly stronger when participants faced losses.

That fear, when applied to buying and selling investments, can hold you back when it comes to long-term financial planning. The unwillingness to part with something for less than you paid for it can keep you clinging to declining investments, whether it’s a stock or depreciating property.

It can also be hard to come to terms with the reality that a purchase may not have panned out like you’d thought. A yacht can be a worthwhile investment for some, but if you don’t have time to enjoy it, the upkeep might cost you more than it’s worth.

WHEN LOSS AVERSION FACTORS INTO YOUR FINANCIAL DECISIONS:

• You might hold on to investments that keep losing value because you refuse to sell below a given amount.
• You may put off uncomfortable conversations around disability, long-term care and legacy planning.
• Sentiment might prompt you to hold on to possessions – or investments – that were gifted to you, even if they aren’t the best fit for lifestyle or goals.
• You might operate too fearfully and miss out on opportunities based on a past negative experience, like a market crash or a saving goal you fell short of.
• You may take on unwise risks to try to counteract an existing loss.

THE GUARDRAIL

Too strong an aversion to loss can hinder a financial plan’s progress. But it doesn’t have to be what holds yours back. While it’s natural – and often prudent – to try to avoid loss, letting that fear loom too large over your financial decisions could actually lead to the very thing you’re afraid of.

Instead, cultivating a healthy relationship with risk could be the key to gaining in the long term and helping to counteract a loss aversion bias. If you’ve been burned by the market before, it’s important to do your best to take a longer view and look past that loss. Instead of dwelling, focus on how moving forward can help you progress toward your goals.

It also helps to work with objective third parties – like our experienced wealth management team – who can offer perspective in addition to financial planning and investment support. What- ever life or the financial markets may bring, having someone you trust looking out for your best interests can help you stay on track for your long-term goals.

THINK BEFORE YOU ACT

To help you keep loss aversion from swaying your financial decisions:

• Let’s look at your holdings with fresh eyes. If you were starting from scratch, which would you still own?
• Look at long-term market data. Experience has shown that events like the financial recession and dot-com bubble were temporary speedbumps in the consistent growth of the market.
• Give careful thought to what your true long-term risk tolerance is. We have the tools to help you stress test your portfolio and make adjustments.

This material is not intended for use as investment advice. It does not guarantee the attainment of your goals. Individual results will vary. There is no assurance that any investment strategy will be successful. Investing involves risk and investors may incur a profit or a loss.

¹ “People place a higher value on a good that they own than on an identical good that they do not own” — Kahneman, Knetsch, and Thaler (1990) 2 “Some studies have suggested that losses are twice as powerful, psychologically, as gains.” Kahneman, D. & Tversky, A. (1992).

Do you sometimes convince yourself you can beat traffic or time the market? Discover how overconfidence can undermine your financial plan and learn how to outsmart your subconscious.

You’ve got this. Or do you?

DON’T LET OVERCONFIDENCE UNDERMINE YOUR FINANCIAL HEALTH.

Overconfidence. It’s what leads people to under-estimate traffic or overestimate how much they can fit into a day. It’s also what led some of history’s greatest leaders to their downfall. But what does it mean for you and your financial goals?

UNDERSTANDING OVERCONFIDENCE

In simple terms, overconfidence is our tendency to overestimate what we know or what we’re capable of.

It usually trips us up in small ways, often giving us blind spots about individual traits, like how quickly we can complete a list of chores or how our navigational skills compare to a GPS.

Overconfidence has been the subject of extensive scholarly scrutiny, studies and surveys, like one that found that 93% of Americans believe they are above average drivers.¹ And another from Harvard found students believed they could predict daily egg production in the U.S. with 98% accuracy but were only accurate 60% of the time.

OVERCONFIDENCE CAN LEAD PEOPLE TO:

• Focus on short-term wins rather than long-term goals
• Gamble and make bets
• Enjoy placing trades or making other financial transactions frequently
• Think they’ve found the next “big thing”
• Stray from their established financial plan

From 1997 to 2016, missing just 10 of the market’s best days would cut an investor’s return nearly in half compared to someone who stayed invested the whole time. Source: JP Morgan

IS OVERCONFIDENCE OVERTAKING YOUR FINANCIAL SUCCESS?

When it comes to money and the markets, overconfidence tends to create the illusion that past success was the result of intrinsic luck. It’s why overconfident investors frequently believe they can time the market, despite the high rate of failure for those who try.

Overconfidence can also lead us to underestimate the possibility of a costly life event down the road, such as an illness, divorce or disability. According to AARP, a quarter of people age 45 and over are not financially prepared should they suddenly need long-term care for an indefinite period of time.

Other times we overestimate how long we have to save for retirement or our long-term goals. Young professionals might put off making contributions to their 401(k) and thereby forfeit the benefits of compounding. Or, individuals in or nearing retirement or our long-term goals. Young professionals might put off making contributions to their 401(k) and thereby forfeit the benefits of compounding. Or, individuals in or nearing retirement

WHEN OVERCONFIDENCE CREEPS INTO FINANCIAL PLANNING…

• You might take past successes – due to luck or external factors like broader market trends to mean that you’ll be successful with future selections.
• You might eat away any gains with high transaction costs and taxes from regular buying and selling.
• You might have loose ends in your estate plan.
• You may not plan for the possibility of long-term care.
• You might miss or ignore signals and external advice that suggest making a change.

THE GUARDRAIL

Overconfidence can undermine the success of a long-term financial plan. Fortunately, it doesn’t have to be the downfall of yours. Start by taking a more objective look at past successes. How much was due to your actions? How much was due to external circumstance? How much was luck? How much was good planning?

Apply this lens of objectivity to the future, as well. If you have instincts regarding a certain investment, consider what exactly is motivating those feelings. Objective research and information or a one-time stroke of luck?

The reality is that staying objective can be a challenge if your voice is the only one in the room. That’s why I work closely with individuals like you to provide the information, resources and experienced insight you need to make sound decisions regarding your wealth and future.

While believing you can always beat traffic likely won’t have dire consequences, overconfidence can sabotage your decisions when it comes to more important and complex matters. By taking steps to counteract it, we can help keep you just the right amount of confident when it comes to achieving your goals.

THINK BEFORE YOU ACT

To help you keep overconfidence from derailing your financial plan:

• Remember that past performance doesn’t guarantee future results.
• Consider the real source of your gut feelings. Does data or external research back you up?
• Take a look at the fee and tax consequences of your investment activity. Do the gains outweigh those costs on a consistent basis?
• Account for the unexpected in your financial plan, such as an illness or disability.
• Seek out the perspectives of people whose beliefs differ from your own and professionals with specialized expertise.

¹ Ola Svenson, ‘Are We Less Risky and More Skillful than Our Fellow Drivers?’, Acta Psychologica, 47 (1981), 143–51

By only focusing on the details, you can miss big opportunities. Discover how mental accounting can hold you back, and learn how to help outsmart your subconscious.

DON’T MISS THE BIG PICTURE

When you focus only on the details, you can miss big opportunities

Mental accounting. It’s a bias that can keep you so caught up in the trees, you miss the forest. So focused on the details you miss the bigger picture they paint. It’s why people treat an annual bonus differently than the rest of their earnings or overspend while on vacation. And it can add up to trouble for your financial goals.

TAKING ACCOUNT OF MENTAL ACCOUNTING

Mental accounting is the tendency we sometimes have to treat the same thing – money, in particular – differently depending on where it came from or what we intend to do with it.

Consider this scenario: You buy a movie ticket in advance, but when you arrive at the theater, it’s nowhere to be found. What if it were the cash in your pocket that had gone missing? Would you be inclined to spend additional money to replace the ticket or to “replace” the lost cash?

A study that posited exactly this situation found that just 46% of respondents would spend additional money to replace a lost movie ticket – since they’d already spent the money they’d mentally accounted for that purpose – but 88% would spend again if it were cash they lost.¹ Even though the two scenarios are effectively identical, our brains tend to treat them in completely different ways.

70% of winners of lottery windfalls end up bankrupt, and the more they receive, the likelier they are to go broke. Source: CNBC, Don’t fumble a financial windfall: Plan a strategy

MENTAL ACCOUNTING CAN LEAD PEOPLE TO:

• Focus on individual account performance rather than their overall portfolio
• Hold fast to certain principles (eg. I must open a savings account for my child; I must pay off all debt as quickly as possible.)
• Feel most comfortable holding cash or low-risk securities
• Think of a holiday bonus or tax refund differently than a regular paycheck

IS MENTAL ACCOUNTING GIVING YOU TUNNEL VISION?

Mental accounting hinges on the idea that all money is interchange- able, but we frequently fail to treat it that way, leading us to sort our assets into distinct “accounts” both figuratively and literally.

For example, the tendency to treat windfalls differently is one of the greatest threats mental accounting can pose to your finances. You see it in the incredible rates at which lottery winners end up bankrupt or how 80% of NFL players have depleted their mammoth fortunes within just three years of retiring from the competitive field.²

But mental accounting also operates on a smaller scale, leading people to do things like spend an unexpected inheritance on a luxury purchase instead of saving it like they would other income. Or to shortchange their long-term goals because they’re too focused on the short-term performance of one particular “bucket.”

33% of people – and 50% of millennials – plan to use their tax refunds to pay for travel. Source: Detroit Free Press

WHEN MENTAL ACCOUNTING FACTORS INTO YOUR FINANCIAL PLAN:

• You might undercut your financial progress by treating certain inflows (bonuses, tax refunds) as more “spendable” than others (like your regular paycheck)..
• You’re so focused on certain goals, like funding a child’s college tuition, that you neglect long-term ones, like retirement.
• You might lock in losses if you’re saving money in low-risk vehicles but paying a higher interest rate on any form of debt.
• You might miss out on gains if you’re paying off low-rate debt faster than necessary when you could receive a better return by investing that money.
• You might trigger the wash sale rule (which applies across your accounts as well as your spouse’s) if you sell a security for the tax benefit in one account but unwittingly repurchase a substantially identical security in another.

THE GUARDRAIL

Mental accounting is one of the surest ways to keep a financial plan from reaching its full potential. While it’s important to pay attention to the little things, remember that sometimes the most important step toward achieving your long-term financial goals is taking a step back. Leverage tools from your financial institutions that provide a comprehensive view of your various accounts and can help you better clarify your financial needs and goals.

Just as important is ensuring you have a reliable source of objective information and guidance. Seek out the perspectives of people whose beliefs differ from your own and professionals with specialized expertise. As your financial advisor, I can serve as an unbiased third party, offering the perspective you need as well as comprehensive financial planning guidance to help you move toward your future with confidence.

THINK BEFORE YOU ACT

To help you keep mental accounting from derailing your financial plan:

• Treat money with the same careful consideration no matter where it comes from or how you plan to use it.
• Don’t interrupt your financial progress by changing spending habits based on circumstance, whether you’re on vacation or experience a good day in the market.
• Talk with your children and heirs about what it took to build your wealth and what your wishes are for its future, so when the time comes to pass it down, they don’t see it as a “lottery win” and misspend.

¹Psychology Today, Mental accounting and self control
²Forbes