Aligning Your Personal Biases With Your Portfolio Strategy

Mark Nickel, Wealth Manager, First Republic Investment Management
May 8, 2017

Whether they are aware of it or not, many investors and investment professionals approach their investing with personal biases. These biases may stem from their values, life experiences, political ideals or an affinity or distaste for a particular company or industry.

Having a point of view is natural and, in fact, aligning your biases with your investment decisions may make you a more engaged and committed investor. What’s important, however, is to acknowledge and understand your biases as you design your investment strategy while not undercutting your primary long-term investment objectives.

Below are considerations for investors seeking to fit their values in their portfolio strategy.

Company, product or business sector bias
Investors may express an interest in having or restricting exposure to specific areas of the equity market. They may prefer, for example, to be over- or underexposed to a particular geographic region, an area of biopharmaceutical research or a specific technology. Or they may want little to no exposure to a company with practices they feel are environmentally or socially harmful or associated with a particular political figure.

These are all biases that can be addressed by identifying stocks of individual companies that meet the values-based criteria set by the investor. This provides him or her with the benefit of transparency, knowing precisely what business practices the companies are engaged in.

However, not every bias is as easy to invest around. Very broad biases, such as avoiding companies that use animal testing or those that derive a large portion of their revenue from defense contractors, can be more challenging to address while still maintaining a well-diversified investment portfolio.

For example, while most pharmaceutical and consumer product companies have reduced their reliance on animal testing over the past 30 years, they still use animals to test the efficacy of — and safety to — human consumers for many of their products. Similarly, it can be difficult to completely avoid all companies that sell products to defense contractors. Many large industrial, technology and energy companies, for example, that are not typically known as suppliers to the Army, Navy or Air Force now do business with the U.S. Department of Defense.

Familiarity bias
This bias occurs when there is an overwhelming preference for familiar companies that may prevent investors from accurately judging the appropriateness of the investment or preventing them from building a well-diversified portfolio. Investors can become biased toward certain stocks or businesses that they know well and frequent as consumers.

This can be a misleading instinct if you become convinced, for example, that a busy restaurant in your local community means that the company that owns the restaurant must then be a good investment. Likewise, just because you use and like a particular electronics brand doesn’t necessarily mean the company’s stock deserves a place in your portfolio.

Before selecting a company’s stock to invest in, you should understand its business, the markets it operates in and its future vision and prospects. Unconscious behavioral bias shouldn’t become a hindrance to a good investment decision.

Current events bias
This is a common behavioral bias that can be counterproductive if an investor makes emotional decisions based on a perceived shift in policy or changing conditions in Washington, D.C. People may consider tactical shifts in investments due to anticipated easing of the corporate regulatory environment, corporate tax reduction or increased infrastructure spending promoted by the current administration — and these could be sound strategies, when backed with a qualitative evaluation by an investment professional. However, the market’s long-term behavior is not generally determined by the actions of the current president or Congress, even if those actions drive short-term market responses or swings. A thoughtful analysis of revenue and earnings growth expectations under a new policy paradigm can help take the emotions out of important investment decisions.

Keeping your balance
While it’s important for you and your advisor to have conversations about how your personal biases fit into your investment strategy, it is also important to be realistic about where lines are being drawn over  what should — or should not — be invested in.

First, work with your advisor to define your long-term investment goals; this will allow you to select securities and create an asset mix that meets those goals while also aligning your investment decisions with your values.

It’s natural — even motivating — to approach your investment strategy through your unique worldview, values and experiences. But it’s also important to acknowledge that certain personal biases may make creating an investment portfolio with the performance targets you’re aiming to achieve more challenging. Designing your portfolio with your personal biases in mind can be very rewarding as long as you can also meet your core investing objectives, such as diversification and risk tolerance.  

Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.

©2017 First Republic Investment Management