Behavioral Finance Consulting

Over the last fifteen years or so, behavioral finance researchers have begun to show, scientifically, that investors do not always act rationally or consider all of the available information in their decision-making process. As a result, they regularly make errors. This may seem obvious but it does, in fact, represent a radical break away from traditional economic theory which has previously considered investors as being able to make fully rational decisions and investment valuations. It turns out too that the errors they make repeat in the same way, and are, therefore, termed systematic errors. Luckily, because of this systematic character, these errors are often predictable and avoidable. Nevertheless, psychologically determined, they continue to occur frequently in Financial Markets and are usually made by novice investors.

Here are some other systematic errors that we often find:

  • Investors may overestimate their skills; attributing success to ability they don’t possess and seeing order in information or data where it doesn’t exist.
  • Having expressed a preference for an investment, people often distort any other information in order to add weight to their decision.
  • Investors are often unable to alter long-held beliefs, even when confronted with overwhelming evidence that they should fall in love with their investments, rationalize losses, or hang on too long to sell.
  • Most investors will avoid risk when there is the chance of a certain gain. But faced with a certain loss, they become risk takers
  • Investors are often impatient to sell a good stock
  • Investors often make a distinction between money easily made from investments, savings or tax refunds and hard-earned money found is more readily spent or wasted
  • People tend to think in extremes - the highly probable news is considered certain, while the improbable is considered impossible.
  • People feel the loss of a dollar to a far greater extent than they enjoy gaining a dollar.
  • Investors often take a short-term viewpoint. Recent market losses lead to suspicion and caution, while recent gains lead to action.
  • Investors often assume that lack of market or price movement represents stability, while volatility represents instability
  • Investors follow the crowd, and are heavily influenced by other investors or compelling news; they fail to check out the real facts
  • Investors make predictions based on limited information as if they had special foreknowledge.
  • Investments are often thought of as pieces of paper rather than part ownership of a company.
  • Investors become obsessed with prices and trend-watching, rather than solid information.

Taken as a whole, all these errors really have only one effect, that is: a financial decision is taken that lacks accuracy. These errors are strongest when uncertainty, inexperience, attitudes and market pressures come together to undermine decision-making ability.

By virtue of our knowledge of behavioral finance and investor psychology, our aim is to help clients determine whether a financial decision actually makes sense.

Contact us for more details.