Behavioural Finance
The study of behavioural finance explores how humans make financial decisions, and research often shows that we are not very good at it. Understanding your emotional and behavioural tendencies is key to financial success.
As an advisor, I act as a coach, helping clients understand their portfolios, the risks involved, and how they may behave in volatile markets. For example, when your stocks fall 20%, will you want to sell or buy more? When they rise 20%, will you be willing to rebalance?
As Ben Graham, mentor to Warren Buffet once said, "The investor's chief problem - and even his worst enemy - is likely to be himself".
Here are the three most common mistakes that investors make:
If you find yourself chasing the hot stock or the hot sector, remember you’re not alone - eventually prices get pushed too high, and you can only profit by selling to another speculator. Seasoned investors call this the “greater fool” theory.
It's impossible to predict how far markets will fall or how quickly they'll recover. By focusing on fundamentals like valuation and long-term goals, you can look beyond current events and view market downturns as opportunities.
Investors are overwhelmed with information, and have a tendency to rely on what feels right. However, asset allocation and diversification are more important for achieving long-term goals.
Not surprisingly, research often shows that monitoring your portfolio less often leads to better long-term results. Despite this, many investors and advisors believe value is added with every trade, though research shows that only rebalancing your portfolio back to long-term targets truly add value – selling winners to buy losers. While trading at the margins can be tempting, having a solid core strategy is crucial.
Lastly, choose an advisor with a strong financial and academic background, someone who can determine which ideas align with your long-term goals.
Learn More
Hard-Wired Biases Affect Our Decisions
The tendency to overestimate one's own abilities, knowledge, or predictions, leading to excessive risk-taking and flawed decision making.
The tendency to favour information that supports our current opinion, such as focusing only on positive data about a sector you like. Overcome this by using objective criteria to assess an investment's intrinsic value.
Recency bias leads us to rely on recent events as predictors of the future. While past performance may reflect skill, luck also plays a role, and strong results don't guarantee future success. Maintaining objectivity is key to overcoming this bias.
This involves holding onto losing investments too long, or selling winners too quickly, driven by emotional decisions. Set clear goals to let fact, not emotions, guide your buy and sell decisions.
This is the tendency to prioritize immediate needs over future ones. Combat this by creating a retirement plan that estimates future living costs and determines how much to save now. Automating your savings ensures consistent progress.
Hindsight bias is the belief that past events were obvious and predictable, when in reality they were not.
This involves attributing success to your actions and blaming failures on external factors, often leading to overconfidence in investing.
Worrying is natural but can distort judgement, increasing perceived risk and lowering risk tolerance. Know Your Client (KYC) questions help match risk tolerance with a balanced portfolio, but education and financial literacy serve as an effective defence against worry. The more investors understand their investments, the more likely they are to embrace the risk needed to reach their goals.