When It Comes to Investing, the Default Bias Can Be a Big Problem

The sheer volume of choices in life can be overwhelming.

Restaurant wine menus can run for pages, our phones has hundreds of different settings and the grocery store has dozens of types of breakfast cereal. But we still often just settle on the house wine, the pre-set factory ring tone and a box of Cheerios.

This is called the default effect. It means we choose things with which we are familiar and go with what is easy and comfortable.

(To find out how to avoid losing money from falling prey to these types of cognitive biases, click here).

Governments and corporations know that is the natural thing for us to do. So they use the default effect to subtly manipulate us into making certain decisions.

For example, an experiment was done with one country's organ donor program. When the default option was to not donate organs at death, just 40% of people opted to donate.

But when the default option was changed to donate organs, the percentage of people willing to donate increased to 80%. By switching the default option to being an organ donor, the number of donors doubled.

Even when there is no standard option, we use our own default settings from the past. We stick to what we know and avoid making big changes, even if deviating from what we have always done would be good for us.

This ingrained default bias springs from two other biases: status quo, when it is convenient and easy to keep things the same; and loss aversion, when the joy of winning is less than the pain of losing. The brain combines these biases and instructs us to just keep things the same.

It is perceived as safe and eliminates any potential losses attributed to change.

When it comes to investing, the default bias can be a problem. It tells us to accept what our financial adviser tells us, to buy what they are selling and to keep our portfolios or strategies the same.

And while this may be easier and more convenient, it may not be the best decision.

This same default bias can cause a portfolio to drift or stray from its goal.

For instance, an investor may want a balanced portfolio with a mix of stocks and bonds. But in a rising stock market, a portfolio could become unbalanced, with too high a proportion in stocks.

It may be tempting to leave a portfolio as is in this situation. After all, it is growing in value, but it also leaves an investor overexposed to the stock market.

It would be better to give the portfolio a trim and sell some stocks to lock in gains.

Overcoming default bias is difficult because falling into it is, well, a default.

Here are a few ways to fight the tide of default bias:

1. Do something different. Make a conscious effort to not order the house wine, the set menu or whatever the usual is. That won't change anyone's life, but it might help break a mental logjam that could be the start of something good.

2. Analyze one's thinking. Occasionally, step back to look at oneself from the outside. What does one's decision-making process look like from another point of view?

3. Look at other options. These might have been rejected long ago, and they might be rejected still and again. But sometimes new options are discovered or previously discarded options become more attractive.

Overcoming default bias means inviting change, which is usually uncomfortable and inconvenient. But in investing and in life, it usually pays off in the long run.

To see a report about other cognitive biases, click here.

Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.

This article is commentary by an independent contributor.