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Behavioral Finance 101 (Part 6)

Key Points

  • Overconfidence and loss aversion can both lead to poor investment performance.
  • Overconfident investors tend to hold overly concentrated investment portfolios, which can increase idiosyncratic risk, and overall risk of loss.
  • Loss aversion can lead to under-participation in the markets, such as by going to cash when the markets begin to falter. This too can degrade investment returns over time.

Continue reading → Behavioral Finance 101 (Part 6)

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Behavioral Finance 101 (Part 5)

Key Points

  • Statistically, it’s sensible to take a wager if the odds are in your favor.
  • Nevertheless, the bias of Loss Aversion notes that individuals will carefully consider the magnitude of potential losses relative to the gains before making such a bet.
  • This notion and many others are based upon the pioneering work of Amos Tversky and Daniel Kahneman, two highly influential researchers in the field of behavioral economics.

Continue reading → Behavioral Finance 101 (Part 5)

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Behavioral Finance 101 (Part 4)

Key Points

  • Initial bad experiences can lead us to avoid taking risk even when risk-taking can provide substantial benefit.
  • This is Primacy Bias at work, once again; and its impact can be significant to one’s long-term financial success.
  • When making investment decisions, a great way to combat these types of behavioral distortions is to conduct a complete (beginning, middle, and end) analysis of one’s investments.

Continue reading → Behavioral Finance 101 (Part 4)

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Behavioral Finance 101 (Part 3)

Key Points

  • First impressions matter; whether we like it or not, they guide our behavior and impact our decisions.
  • Furthermore, sometimes our initial judgements are incomplete or based upon a partial understanding of the facts.
  • Primacy Bias is the notion that we often overemphasize initial events over longer-term averages when making decisions about uncertain future events.

Continue reading → Behavioral Finance 101 (Part 3)