Cognitive biases are beliefs that people form over their lifetime. These biases often impact our decisions. One such cognitive bias is known as the “authority” bias, where people tend to accept whatever a perceived authority figure says without question.
The authority bias has significant potential implications for investors. Investors often say they simply accept whatever their stockbroker or other financial advisor tells them without asking questions because they do not want to appear “uninformed” or “foolish.” After all, the stockbroker/financial advisor is the “expert.”
As a former securities compliance officer, I can assure you that many stockbrokers/ financial advisors may be “experts” in selling, but most are far from “experts” when it comes to investment advice. Furthermore, stockbrokers are legally allowed to put their financial interests, i.e., commissions, ahead of their customers’ best interests, and many have no problem in doing so.
When the market is down or a stockbroker’s production is down, brokers are told to “work their book.” This explains why an investor may receive an unexpected call from their stockbroker/financial advisor suggesting that they meet to review the investor’s portfolio and consider changes in the portfolio. Such calls may actually be in an investor’s best interests. Or, the call may be an opportunity for the stockbroker/financial advisor to “churn” or “flip” the portfolio’s investments. Clearly, investment scams.
“Churning” refers to the illegal practice of recommending exchanging similar types of mutual funds for the sole purpose of generating commissions. An example of this practice would be suggesting that an investor exchange one type of growth fund for another growth fund with similar characteristics, where the investor basically receives no benefit from the exchange, but the stockbroker/finanical advisor gets new commission income.
“Flipping,” is similar to churning except that it involves annuities. A stockbroker/financial advisor recommends that a customer exchange an existing annuity for a another annuity, there by generating new and substanting commission income, often in the range of 7 percent. There are some unethical stockbrokers/financial advisors who will recommend making such changes even though the exchange will result in penalties for the investor.
Bottom line – overcome the “authority” bias and always ask “why?”. It’s your money, your responsibility to protect it from unethical stockbrokers and other financial advisors. Recognize that most stockbrokers/financial advisors are first and foremost product salesmen, not “experts” “or “authorities” on investment advice. The “advice” they are providing may simply be on a product that is being pushed so that they can qualify for a trip or some other reward.
To learn more about James Watkins, visit his site at www.investsense.com.