Assets Head or heart: listen to the former when investing

Afraid to switch health insurance provider, even though you’ve found a better offer elsewhere? This could be due to status quo bias, in other words, the difficulty of coping with change. We prefer the status quo because we fear new things or simply cannot assess alternatives.

The researchers William Samuelson and Richard Zeckhauser demonstrated the status quo bias by means of an experiment. They presented participants with a hypothetical scenario without a status quo and asked them to make a choice. The task was defined as follows: “You are an avid reader of the financial pages, but until now haven’t had much money to invest. You suddenly inherit a large sum of money from your great-uncle and begin considering various investment options. You can invest either in a) a moderate risk company, b) a high-risk company, c) government bonds or d) municipal bonds.”

Other participants received the same task, but with a status quo already established – this time, a large part of the great-uncle’s legacy was already invested in the company with moderate risk. The experiment showed that participants were more likely to invest in the moderate-risk venture when it was defined as the status quo. The status quo bias thus seems to influence our cognitive decision-making processes when investing.
It can lead to cognitive bias when making financial decisions because investors will not deviate from familiar strategies, even if they are less successful. If you are faced with several complex investment options, you will probably choose the one that prolongs your current situation  regardless of whichever is the most promising.We prefer the status quo because we fear new things or simply cannot assess alternatives.

This bias is also linked to an aversion to loss and regret – in other words, the fear that trying something new could have negative consequences. Be vigilant and question the status quo, as well as your own behavior. Existing methods may not always be the best approach.

People can sometimes develop tunnel vision and fail to see the bigger picture if forced to make several decisions at the same time. This phenomenon is called “narrow framing bias.”

Is your portfolio full of Swiss equities? Then you may be acting based on a “home bias.” This is the belief that we know the domestic market better and can thus better assess and predict its current situation and future developments.

Nowadays, it’s much easier to invest in foreign stocks and bonds. International financial media and the internet have made it possible to obtain differentiated information about foreign markets and their development. It is thus not rational to invest more or less exclusively in domestic securities.

Home bias usually results in a lack of portfolio diversification. Suppose Swiss equities comprise 80 percent of your portfolio. The domestic market now experiences a negative shock similar to that witnessed in early 2015, when the Swiss National Bank abolished the minimum exchange rate of CHF 1.20 per euro.

Or let’s assume that economic conditions in Switzerland have weakened the domestic market. You would feel the impact far more quickly with your less differentiated portfolio. It is therefore sensible not to put all your eggs into one basket, even if the basket is more familiar to you.

In the early days of humankind, it made sense to prioritize the status quo and the familiar in order to survive. When it comes to financial decisions, however, these millennia-old tendencies can be an obstruction. You should thus question your intuition from time to time using the tips mentioned.

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