Question

Scenario #6: Heidi has always been a real estate investor. She tells her financial planner that, because she is such an expert, it’s the only asset worth investing in. However, after a thorough assessment of Heidi’s actual performance, net of costs, her rate of return over time has been about 3.5%/yr on her real estate investing. This is not a bad return, but her planner shows her that diversifying her assets into other investments will not only earn her more return over the long-term, but also reduce her risk (because real estate will not always perform well, and other assets may-when real estate does not do so well). Heidi just can’t believe that something she is so comfortable with could not be as optimal as what her planner is proposing. 1) What behavior/bias is present? 2) Why is this behavior detrimental? 3) What could have been done differently, or what could be done differently next time to avoid this result?

Answer 1

1) The behavior of Financial Planner is not bias and his/her suggestion to diversify the investments/assets in other assets except real estate is in benefit of Heidi. This will lead to less risk taking on part of Heidi.

2) The behavior of Financial Planner is not detrimental to the Heidi investments portfolio. According to Planner, if Heidi diversify her assets she would earn more than what the real estate is providing her ie. 3.5% per year. Rather investing only in real estate is just like putting all the eggs in one basket and if something happens to one, it will affect all the investments. If the return to real estate decreases, it will affect the whole investments as all consists of real estate only. So, if Heidi diversify it will reduces its risk of losing returns on the whole investments.

3) The different behavior could be that Heidi could invest in 4 to 5 different sectors where the future growth exists. So, if one sector does not work towards return, the other remaining sectors will reply in return terms. Thus, the risk of losing return on whole investments could be escaped.