MTTM Podcast Episode 492 – Investors’ behavioural biases, crowdfunding and financial planning week

Listen to Episode 492

On this week's episode, Damien discusses seven of the main behavioural biases that can affect your investment decision making and hurt your investment returns. Damien also explores crowdfunding, the potential rewards, risks and examples of crowdfunding successes and failures. Finally, Andy looks at financial planning week and the free tools and advice that are available for those wanting to sort their finances.

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This show is sponsored by Lightyear*, a new, straightforward platform offering a Stocks & Shares ISA. With no account, subscription or custody fees, Lightyear’s Stocks & Shares (S&S) ISA will be 10 times cheaper than the average market provider over 10 years (based on research conducted by Capital Economics) and its Cash ISA offers easy access to the Bank of England base rate. Both accounts are flexible, so you can withdraw and re-invest without affecting your annual limit. Capital is at risk and ISA rules apply. Other fees - like foreign exchange fees - may apply. Lightyear UK Ltd is authorised and regulated by the Financial Conduct Authority

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Episode 492 Podcast Summary

Behavioural biases when investing

Summary:

In the first section of the podcast I focus on the various behavioral biases that can impact investment decisions. As humans, we are naturally poor investors, often tripped up by our own minds and cognitive biases. I discuss seven key biases, including loss aversion, confirmation bias, anchoring bias, hindsight bias, recency bias, herding bias, and overconfidence bias. While it's difficult to completely avoid these biases, understanding them and taking steps to mitigate their impact can help improve investment decision-making.

Key Insights:

• Loss aversion can lead investors to hold on to losing investments out of fear of realizing losses.
• Confirmation bias causes investors to seek out information that confirms their existing beliefs while ignoring contradictory evidence.
• Anchoring bias leads investors to over-rely on the first piece of information they receive, even if it's irrelevant.
• Hindsight bias makes investors believe past events were predictable, leading to overconfidence.
• Recency bias causes investors to give more weight to recent events or performance, neglecting long-term perspectives.
• Herding bias, or FOMO, can drive investors to follow the crowd without considering their own judgment.
• Overconfidence bias leads investors to overestimate their abilities, leading to riskier bets.

Crowdfunding

Summary:

In this section of the podcast I explain how crowdfunding can be used as a way for businesses, charities, and individuals to raise money or capital without relying on traditional routes like bank loans or private equity. I discuss the different types of crowdfunding, including: equity-based, loan-based, donation-based, and reward-based. I also highlight the potential rewards and risks associated with crowdfunding, reminding listeners that it is a high-risk activity, particularly for equity-based investments, where the majority of startups tend to fail.

Key Insights:

• Equity-based crowdfunding allows investors to buy shares in a company, giving them a stake in the business.
• Loan-based crowdfunding, or peer-to-peer lending, involves lending money to individuals or businesses with the expectation of repayment with interest.
• Donation-based crowdfunding is where people donate money without expecting anything in return, often used for charities or personal causes.
• Reward-based crowdfunding involves receiving a reward, such as a product or service, in exchange for contributions.
• Crowdfunding investments are not protected by the Financial Services Compensation Scheme, and investors may lose all their money if the company fails.
• Behavioral biases, such as FOMO and hindsight bias, can heavily influence crowdfunding decisions, leading to irrational investment choices.
• The ultimate outcome for crowdfunding investors can be dependent on decisions made by the company's management, including any future sales or IPOs.

Financial Planning Week

Summary:

In the final section of the podcast, Andy discusses Financial Planning Week, an initiative organized by the Chartered Institute for Securities and Investment. Andy explains that the week-long event provides people with the opportunity to access free financial advice. While only running for one week, Andy highlights that Money to the Masses offers free financial consultations and reviews all year round on our website.

Key Insights:

• Financial Planning Week runs from January 27th to February 2nd, providing free financial advice sessions.
• Money to the Masses offers free financial consultations and reviews throughout the year, not just during Financial Planning Week.
• The Money to the Masses website also provides access to resources for mortgage advice, life insurance, and critical illness cover.

Episode quiz

Questions

1. What did Warren Buffett emphasise the importance of knowing in relation to behavioural biases?
   a) Your risk tolerance
   b) The market cycle
   c) Your circle of competence
   d) The efficient market hypothesis
2. What is the name of the UK app-based bank that successfully raised £20 million in under three hours through crowdfunding?
   a) BrewDog
   b) Monzo
   c) Freetrade
   d) Zopa
3. What is the one way to mitigate the impact of market falls on your investments?
   a) Invest in individual stocks instead of funds
   b) Increase your investment timeframe and review your portfolio regularly
   c) Sell all your investments at the first sign of a market downturn
   d) Time the market to buy low and sell high
4. Which bias is characterised by over-relying on the first piece of information received, even if it's irrelevant?
   a) Hindsight bias
   b) Anchoring bias
   c) Recency bias
   d) Endowment bias
5. Which of the following is a risk associated with crowdfunding?
   a) High failure rate of startups
   b) Investments are not protected by the Financial Services Compensation Scheme
   c) Difficulty selling shares due to unlisted companies
   d) All of the above

Answers

1. c) Your circle of competence
2. b) Monzo
3. b) Increase your investment timeframe and review your portfolio regularly
4. b) Anchoring bias
5. c) All of the above

Resources

Links referred to in the podcast:

• Can you solve this (YouTube video)
• Get a FREE Financial Review
• Get a FREE pension review
• Financial Planning Week
• Top 5 alternatives to Vanguard