What Is Behavioral Finance

| May 26, 2018
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I wanted to refresh my Investor Character Equation of Stimulus + Reaction = Outcome with some research from The Behavioral Edge by Fuller & Thaler.

Traditional finance and investing techniques are based on one key variable: that investors act in a rationale capacity – always.

The Efficient Market Theory is based on the following:

  • Accurate Forecasting
  • No Emotions
  • Unbiased Judgement

Theoretically, if the S&P 500 is +8.2%, the average investor will be +8.2% over the same time horizon.

Behavioral Finance is based on the theory that investors are indeed human and not robotic.

This realistic version is based on the following:

  • Use Imperfect Rules of Thumb
  • Have Emotions
  • Make Flawed Assumptions

Therefore, investors ARE biased. This leads to the Behavioral Gap.

DALBAR conducted a study over a 20-year time period ending in 2015 that showed this Behavioral Gap.

In actuality, the S&P 500 over this time period was +8.2%. HOWEVER, the average investor return was just 2.1%.

This is one of the reasons the following quote is on the front page of my client presentations:

“The most important investment ability is an emotional discipline.” ~William Bernstein

 

Stay Tuned, Disciplined & Patient! {TJM}

The Investor & Character Equation (ICE) | S + R =

 

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