If you’ve been reading our recent articles, you’ll be aware by now that we base our investment philosophy on scientific criteria. This takes the guesswork and emotion out of it, and is proven to generate better results.

For most people (except Vulcans), emotions affect their investment decisions. For example, greed and fear play a role in driving stock markets.

In the words of Mr Spock from Star Trek: “it’s not logical”.

‘Behavioural Finance’ is the study of the psychology of financial decision-making. It notes that decision-making is hampered by biased behaviours. By becoming aware of these biases we can lessen their impact.

Here are the three most common biases according to Vanguard.

Overconfidence

When people are asked whether or not they are a good driver, less than 50% say they are ‘below average’ – which is obviously impossible as it just doesn’t add up.

Similarly, overconfident investors overestimate their ability to make good decisions. We say you must not get hung up on your gut feel about good investments. Instead, you should diversify.

Overconfident investors might trade too often. We say long-term investment is better than short-term.

They assume good results are due to their ability, while poor results are just bad luck. We say it’s all down to science.

Loss aversion

Behavioural Finance finds that people are more sensitive to losses than gains. They tend to sell any gains but hold on to a loss in the hope that it will return to a breakeven position. It’s called the ‘disposition effect’.

As you probably know, all financial advisers have to measure your attitude to risk before they can advise you.

Inertia

Where there is confusion, people like to wait and see. This is because they are driven to avoid regret, which delays them taking action about financial planning, saving, and updating their portfolio.

As with organ donation cards, an ‘opt out ‘approach works better than ‘opt in’.

That’s why we enforce regular reviews for our clients.

We can’t promise that you will live long, but at least we can help you to prosper. (Do you see what we did there?!)

Read Part 1 of this article

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