Behavioral finance biases

The pandemic truly accelerated the adoption of digital financial services. According to the 2021 Financial Inclusion Survey of the Bangko Sentral ng Pilipinas, 60 percent of those that performed financial transactions online, such as fund transfers and payments, jumped from 17 percent in 2019 to 60 percent in 2021. The report also showed that the number of Filipino adults with financial accounts increased from 20.9 million in 2019 to 42.9 million in 2021, evidencing the advancement of financial inclusion in the country.

 

But this is half of the battle being won. The Philippines’ financial literacy standing remains dismal, with a 2022 World Bank report revealing that the Philippines had a 25-percent financial literacy rating, which is much lower than its neighbors Singapore (59 percent) and Malaysia (39 percent). Financial literacy involves a set of skills and knowledge that enable an individual to make informed decisions regarding his or her financial resources.

The differences in financial literacy across countries are explained by a field of study known as behavioral finance, which posits that there are behavioral anomalies that cause people to judge poorly when it comes to personal finance.

 

In my conversations with different types of investors, individuals and my students alike, I have distilled four behavioral anomalies prevalent among Filipinos:

 

Herd behavior

Herd behavior is the tendency of individuals in a group to act collectively, just like animals in a herd. This is probably the most influential factor when it comes to personal financial decision-making among Filipinos, brought about by our “me-too” culture of copying and mimicking our friend, neighbor or colleague, may it be in business, personal effects and even investments.

A clear example is how thousands of Filipinos fall prey to investment scams that promise high yields ― from the likes of Multitel and Emgoldex fiasco of the 1990s and 2000s to the Bitcoin and cryptocurrency scams of the current times. Scammers continue to rebrand themselves and yet victimize even the schooled individuals.

Even in the stock market, some large stock market trends begin and end with periods of frenzied buying or selling. One of my former students invested in a lesser known company’s initial public offering because his boss and colleagues put their money into it, only to lose a lot because the company didn’t have sound fundamentals.

That’s the problem with herding behavior. People jump into the bandwagon without fully understanding where their money is going or how it’s being invested.

 

Confirmation bias

Confirmation bias is the tendency of people to select one-sided information that supports their opinions, while ignoring the rest, leading to faulty decision-making. Much of this behavior is cultural or deeply rooted beliefs, like the tendency of many Filipinos to keep their money at home or baul (chest) because that’s how their parents saved, or the fear of not getting insurance because of a bad experience in past decades characterized by closures of pre-need companies.

Complementing the herding behavior, confirmation bias explains why individuals who dove into the bandwagon of investment scams cling on to them and succumb to hiya (shame) or avoid losing face; hence, they selectively hear and listen to the “success” stories of phony investors, rather than hear the contradictory advice of others.

 

Mental accounting

This refers to the tendency for people to separate their money into buckets of “mental” accounts based on a variety of subjective criteria, like the intended use of each account or the source of the money. This often leads to irrational and detrimental decision-making when it comes to money matters.

One example is the high credit card debt among Filipinos which leads to many payment defaults. People often have a special “fund” set aside for a vacation or new gadget, while still carrying substantial credit card debt. Many just pay the minimum monthly payment on credit cards which result in a seemingly lifetime of debt.

In this example, it’s illogical to set aside funds for vacation or gadgets that earn no interest at all while carrying a 20-percent annual interest on credit card debt.

In the area of investing, the classic teaching among newbie stock and bonds investors is to divide their investments into safe (bonds) and speculative portfolios so as to prevent the negative returns that speculative portfolios may have from affecting the entire investment. In many instances, despite all the money that the investor spends on the two separate portfolios, his or her net wealth will be no different than if only one larger portfolio is held.

 

Gambler’s fallacy

This is the tendency of a person to erroneously assume that certain random events are less likely to happen following an event or series of events. This thinking is a fallacy as past events do not change the probability that certain events will occur in the future.

Many lotto bettors believe that as time passes, and the longer they bet on lotto, the higher chances for them to win. Even classic gamblers in casinos, horse races and cockfights believe that the more they lose, the closer they are to winning; hence bet some more only to lose their entire month’s income.

Many small business owners also fall into this trap by continuously pouring in money into a losing venture, believing that successive losses may eventually lead to upturns in income.

 

In the end, to change these anomalous behaviors requires a national strategy of education and constant training among Filipinos starting from grade school until adulthood.

The author is the founder and CEO of Hungry Workhorse, a digital and culture transformation consulting firm. He is the chairman of the IT Governance Committee of the Finex Academy. He is fellow at the US-based Institute for Digital Transformation. He teaches strategic management in the MBA Program of De La Salle University. The author may be emailed at rey.lugtu@hungryworkhorse.com.

Source: https://www.manilatimes.net/2023/03/16/business/top-business/behavioral-finance-biases/1882939