Level 5 Financial Blog
This week we’ll discuss the first risk categories mentioned in last week’s general introduction to personal risk. The risk of premature death and longevity risk are distinctly different uncertainties but both can be addressed with insurance products. We transfer (or share) some of these risks with the insurer by purchasing an insurance product specifically designed for the particular issue.
Personal financial risk is anything that exposes a person to the possibility of losing something of value. These risks can take many forms including loss of employment/income, losses on investments, theft as well as many others.
Our final personal finance bias is known as status quo bias. As the name suggests, this bias causes an investor to prefer the current state of affairs. Also known as “investment inertia”, this psychological trap can allow investing mistakes to perpetuate and losses to mount. This behavior is closely aligned with loss aversion, the bias we discussed on July 6. Our preoccupation with avoiding losses and not admitting mistakes causes us to do nothing when corrective actions may clearly be warranted.
Our next personal finance bias is a behavior that is very subtle and insidious. Familiarity bias causes investors to underestimate the risks associated with investing in the securities of an organization that is well known to them. This is very prevalent with employer stock in 401k retirement plans.
Herd instinct is the observed human behavior which causes us to join groups and follow the actions of others. Also known as bandwagon effect, it can explain why people take various actions. It has even been observed in small children who will often want to do “what everyone else is doing.” For investors, herd bias can move markets strongly to the upside, but unfortunately, also to the downside.