Psychological biases can be lifesaving.

If you were in the wild and heard rustling in the bushes, your psychological biases would likely cause you to run in case of a predator. While 9 times out of 10 there would be nothing, your biases have evolved to save you from that one time there is something hidden in the bush that wants to eat you.

However, while this bias and others like it can be useful for helping you survive, they can create issues when they are alerted to situations that require a more measured response rather than blind instinct.

In investing, the difference between returns unaffected by emotions or biases and those that are affected by them is known as the “behaviour gap”.

Read on to find out how financial planning can help you overcome it.

Your biases are not built for long-term planning

As discussed, biases can be incredibly useful for getting you out of life-or-death situations and ensuring survival.

However, the problem is that they kick in at times when they’re not needed, which can often lead to detrimental outcomes.

For example, research reported by UCL found that when you lose money, your brain processes the loss in the same way as pain.

So, when markets dip, you’re likely to feel a reactive response as if you were experiencing something painful. And the most instinctive reaction is to take flight and leave, which would here mean exiting the market.

However, experienced investors know that exiting during a downturn is typically not a good idea, as it hinders them from recovering their losses and benefiting from long-term market trends towards growth.

And the research backs this up. A study by Schroders found that exiting the market after every big decline since the late 19th century would have led to a longer recovery than if you’d remained invested.

So, while your brain may push you to react instinctively to a market decline, the long-term evidence suggests this would not typically be a good idea.

Other biases can trigger the opposite effect.

For example, if a stock has recently delivered eye-catching returns, your propensity for herd mentality may push you to get on the bandwagon and invest. But history shows that chasing yesterday’s winners rarely delivers results.

Further research from Schroders found that in 12 of the 18 years between 2005 and 2022, not a single company that ranked among the top 10 US stocks one year remained in the top 10 the following year. Moreover, an average of only 15 companies a year stayed within the top 100 for two consecutive years.

This shows that strong performance is often fleeting, and following the herd to the latest big thing is typically not a good investment strategy.

The average investor loses around 15% of returns every decade to the behaviour gap

Even though many people are aware of their biases and understand their limitations, it can still be hard to ignore them, and investors often give in. This is where we find the behaviour gap.

A report in Barclays found that the behaviour gap averaged 122 basis points a year in the decade to December 2024. This equates to investors missing out on roughly 15% of their total potential returns.

The report also references wider research suggesting a similar pattern, with the average behaviour gap estimated at around 115 basis points per year.

This means that many investors could have portfolios around 15% higher in value over the course of a decade if they ignore their psychological biases, remain disciplined, and accept that short-term volatility is a normal part of long-term growth.

A financial planner can keep your biases in check

When markets are moving quickly, your biases are likely to be triggered, and there’s nothing a financial planner can do to stop this.

However, what they can do is put structure around your decisions that helps create a space between instinct and action. By doing this, you should be less likely to react to short-term noise and focus more on long-term trends and evidence.

Market volatility is a normal part of investing, and downturns are typically followed by recovery periods. However, the long-term trajectory of markets has historically been towards growth.

A financial planner understands these patterns and can provide perspective when headlines or market returns may be anxiety-inducing.

They will take the time to understand your goals, time horizons, and risk appetite, and then design a plan built around your life, not the latest quarter’s performance. They will also diversify your plan to help smooth over fluctuations in a way that reflects your risk profile.

By combining an understanding of your goals with their market expertise, a financial planner can help you stay focused and disciplined, even when your biases are telling you to do the opposite.

To speak to a financial planner, get in touch.

Email info@blueskyifas.co.uk or call us on 01189 876655.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.