Behavioral Finance: The Value of Advice
Addressing tendencies that can limit decision-making.
Senior Vice President
Whether you are a seasoned veteran with nine bear markets of experience or a rookie investor, we all have emotions and these emotions affect our ability to make sound decisions.
Have you ever bought an investment where other investors made money and you lost money because you were late to the game? Buying high and selling low is all too frequent an occurrence with personal investments. Unfortunately, we are all human and the emotions of fear and greed contribute to poor decisions.
Successful investors are able to reduce the role that emotion plays in their decisions and use logic. It sounds simple, but in today's world of immediate information, distractions are overwhelming. Avoiding hype and the temptation to make impulsive investments is just one of the many challenges. History suggests the popular investment at any given time usually is not the best investment.
One behavioral challenge I have observed often in the past few years is recency bias. This is simply the belief that what has happened in the recent past is likely to be repeated in the future. The financial crisis of 2008 was an historical and nearly unprecedented extreme. However, many investors believe that another 50 percent market drop is imminent, and have felt this way for a couple years. Meanwhile the S&P 500 has more than quadrupled from its bottom in March 2009, and is on track to generate double digit annual returns for the eighth time in the last 11 years.
Another pitfall I see investors fall victim to is personal bias. When an individual loves coffee, they may own more Starbucks. If they worked at Enron, they invested in Enron. How about Google or Facebook? If you love your iPad, should you buy Apple stock? Perhaps, but it should not be based on your personal opinion of your iPad, good or bad. To avoid personal bias, use your Financial Advisor who can offer an objective view. They will allow you to take a step back, assess the valuation, do research, and encourage you to talk to others with different points of view. While I agree with Peter Lynch who advocated investing in what you know and understand, I am confident he never bought a stock simply because he personally experienced one crowded store. Rather, he backed up his personal experience with extensive, unbiased research.
Learning about behavioral finance, common investor pitfalls, and your own personal tendencies may ultimately be more valuable than searching for that perfect investment. As Financial Advisors, we understand investments, but also accept there is no crystal ball and that it may be more important to understand our clients. The next time you want to act on news, remember your own personal tendencies and the way behavioral finance can lead you astray when your Financial Advisor encourages you to stick to the plan, ignore the media noise, and remain disciplined.
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