AB Advisor Institute Blog

Practical guide to investor behaviour

23 June 2025
4 min read
Practical guide to investor behaviour

Managing client emotions can be tough. And even the most seasoned investors can often display non-rational behaviours.

In today’s dynamic investment landscape, understanding the psychological forces that drive investor decisions is more important than ever. But while it’s easy to see how clients can act irrationally, not many advisers fully understand how their own decisions can be vulnerable, too.

Nobody’s Immune: Behavioural Wiring Is the Same for All

What happened the first time you saw an optical illusion (Display) that fools your eyes into thinking one line is shorter or longer than the other? Were you surprised to learn that the lines are actually the same length, or did you take the time to measure them?

Which Line is Longer? Are You Sure

For illustrative purposes only

These types of illusions are an example of how the brain’s perception and processing can break down. We make quick decisions based on limited data, a guess, past experience or a gut instinct. Simply because we’re human, we use flawed decision-making to navigate our world.

Everybody Makes Mistakes—Or Do They?

Let’s take a deeper look at the implications of making imperfect decisions. Decision-making is a complex process, influenced by built-in, instinctive elements.

Mohnish Pabrai, managing partner of California-based Pabrai Investment Funds, studied every deal Warren Buffett and Charles Munger made and read every book he could find about the decision processes they used to make Berkshire Hathaway incredibly successful. “Munger and Buffett saw the dot-com bubble a mile away. These guys were completely clear,” Pabrai said.

Despite Munger and Buffet’s disciplined, unemotional approach to investing—a hallmark of their style—they were caught by surprise when an investment in CORT went downhill quickly. As it turns out, CORT, a Virginia-based rental furniture business, was leasing furniture to hundreds of start-up companies. When the dot-com bubble collapsed, these customers suddenly stopped paying their bills.*

How could such a mistake happen? Pabrai suggested that even though Buffett said he used a mental checklist, he wasn’t really applying it consistently.

Daniel Kahneman, a behavioural finance thought leader, suggests that there are two basic thinking styles: fast (using heuristics or mental shortcuts) and slow (with comprehensive analysis). Most of us like to think we’re thorough and deliberate when we make important decisions, but experience and research reveal the opposite. Even investment luminaries like Warren Buffett can get tripped up by heuristics.

System One and System Two Thinking

Source: Kahneman, D (2011). Thinking, fast and slow. Farrar, Straus and Giroux, 2011

How Do We Really Decide?

Decision-making is more diverse than just “fast” and “slow.” There are four unique decision-making approaches: guessing, heuristics, habits and analysis (Display). Three of the four produce easy answers to hard questions. Most of us prefer the simple solution, so when we’re stressed or short on time, our brain pushes us to use shortcuts. It looks for a simple answer to a difficult question.

How We Make Decisions

For illustrative purposes only

It’s much easier to approximate a solution than to accurately calculate one. It’s simpler to guess and arrive at a quick decision. For example, it’s easy to estimate that the sum of two numbers will be larger than either of the numbers alone. But it takes much more mental effort to calculate the exact answer.

Fortunately, once you’re aware of the common decision-making vulnerabilities that advisers are prone to, it’s possible to recognise many of them. And awareness is the first step in fixing a problem before it impacts your business.

A Framework for Effective Client Engagement

The team at AB has built an adviser framework that outlines a structured, seven-step approach for client meetings:

1. Engage & Listen: Use open-ended questions to understand client concerns.
2. Present a Professional View: Start with a broad market overview.
3. Review the Plan: Reaffirm goals before discussing performance.
4. Discuss Portfolio Performance: Help clients avoid narrow focus.
5. Address Concerns: Respond rationally to emotional reactions.
6. Confirm Next Steps: Clarify actionable items.
7. Set Future Check-Ins: Maintain regular contact to build trust.

Advisers are also encouraged to use pre-decision checklists to counteract their own biases and ensure decisions are aligned with client goals.

Behavioural finance is indispensable for guiding clients through volatile markets. By recognising and managing emotional and cognitive biases, advisers can help clients make more rational, informed decisions—ultimately supporting their long-term financial well-being and resilience in the face of uncertainty.

Contact us to discuss this further.

*Atul Gawande, The Checklist Manifesto: How To Get Things Right (2010)

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams, and are subject to change over time.