As human beings, we have the tendency to get in our ways and sabotage the good things in our lives. Plagued by irrational behavior, we sometimes make decisions to the detriment of our relationships, careers, and good standing in our communities.
Scientists and psychologists study these behaviors and have identified behavioral biases that influence our decision-making and explain our irrational and poor actions.
With an understanding of human behavioral biases, many scientists and psychologists have published volumes on overcoming these “human tendencies” and behavioral biases that prevent us from making good decisions. They’ll offer certain tips for averting irrational behavior to make rational decisions. They’ll tell you that you can avoid certain bad behavior if you take certain steps. It’s like taking a deep breath and counting to three when you feel yourself getting angry.
Like it or not, many biases are shaped by family, school, culture, society, life experiences, and even genetics. And in finances, investors are not immune from behavioral biases that cause irrational investment choices. These biases are impacted by the same factors listed above. And one of the most influential biases that impact investor behavior is the Status Quo Bias.
The Status Quo Bias is rooted in people sticking with what’s familiar and not liking change. They prefer things to stay the same and don’t like making decisions against the status quo. This is why people stick to traditional investment options like stocks, bonds, mutual funds, and 401(k)s. These are investments they’ve been conditioned to accept as the status quo.
The Status Quo Bias explains why investors cling to traditional investments like stocks.
Many public companies produce the household brands we are familiar with and that we grew up using. What can go wrong with investing in familiarity? By investing in the status quo? The answer is A LOT can go wrong, as evidenced by the recent rash of corporate bankruptcies.
Due to higher interest rates that have boosted borrowing costs, corporate bankruptcies in the U.S. are on pace to approach levels not seen since the height of the COVID-19 pandemic and the wake of the global financial crisis. Corporate bankruptcy filings this year reached 402 at the end of July, surpassing the 373 recorded during all of 2022, S&P Global Market Intelligence said in a recent report. Filings are on pace to reach pandemic, global financial crisis levels.
Investors sticking to familiarity, known commodities, and household brands may be in trouble based on recent corporate bankruptcies. The last time the economy experienced such widespread corporate failure was during the Financial Crisis when investors saw the stock market drop more than 50%, along with their portfolios and 401(k)s.
Smart investors don’t succumb to Status Quo Bias. They have coping mechanisms to shake influences such as tradition, upbringing, society, school, and work that steer irrational decision-making. These coping mechanisms help them make rational investment decisions that prevent them from falling into the same traps the average investor falls into from sticking to the status quo. One coping mechanism is looking at the data when making an investment decision.
To avoid behavioral biases, smart investors focus on the data. They look at the facts, math, numbers, demographics, economic indicators, trends, and quantifiable metrics. Focusing on an investment’s data and underlying economics is why sophisticated investors invariably gravitate towards private market investments for their portfolios. That’s because private investments are insulated from the herd. Because private investments like real estate and private company investments (i.e., private equity) are not traded on public markets, they are not susceptible to the same violent market movements experienced by public equities in uncertain times.
Because illiquid alternative investments like real estate and private equity have long lockup periods and cannot be traded or disposed of instantly like public equities, this prevents investors from acting on their impulses. Illiquidity is a coping mechanism. It’s like the overeater who locks up a fridge with a padlock and gives the key to the wife. It prevents him from acting on his impulse of overeating. Irrational urges can overcome even the best of investors, but if there’s no way to act on these urges, these investors can save themselves.
Illiquidity is an ideal stopgap measure for preventing bad investment choices.
In uncertain times, sticking to the status quo and what’s familiar (i.e., household brands) can cost you dearly.
To avoid bad investment choices, consider coping mechanisms that have helped numerous ultra-wealthy investors break tradition and find wealth in illiquid private investments. By focusing on the data and metrics, sophisticated investors can drown out the noise and base their decisions on concrete factors to make the best and most rational investment choices for their portfolios.
Kyle Jones is a co-founder and Key Principal of TruePoint Capital, LLC. Kyle is responsible for the company’s strategic planning, investment decisions, asset management, and overseeing all aspects of the company’s financial activities, operations, and investor relations.
Kyle obtained a Bachelor of Science degree from Texas State University – San Marcos, where he also played Division 1 Baseball.
