The Importance of Understanding Behavioural Finance

…or why does the average investor make such poor financial decisions?

Recent research shows that the average investor makes decisions based on emotion, not logic; most investors buy high on speculation and sell low in panic mode.

The Boston-based Dalbar in its 2007 report “Quantitative Analysis of Investor Behaviour” found that in the past 20 years the American S&P 500 Index returned on average 11.8% pa, while the average investor earned 4.3% pa – substantially lower returns.

The main reasons for the variance was the tendency for the average investor to sell after a stock price has fallen a long way and then buy back in to the market after it has already risen a large amount. Effectively the average investor is buying high and selling low, and thus making losses.

Behavioural Finance seeks to account for this behaviour, and covers the rationality or otherwise of people making financial investment decisions.  Understanding Behavioural Finance helps us to avoid emotion-driven speculation leading to losses, and thus devise an appropriate wealth management strategy.

Behavioural Finance covers “individual and group emotion, and behaviour in markets. The field brings together specialists in personality, social, cognitive and clinical psychology; psychiatry; organizational behaviour; accounting; marketing; sociology; anthropology; behavioural economics; finance and the multidisciplinary study of judgment and decision making”. (Source: Journal of Behavioral Finance)

Read a general introduction to Behavioural Finance »

Archimedes Financial Planning closely follows this field of study in its approach to wealth management, thereby benefiting its clients.

Contact us today to discuss the relevance of behavioural finance to your personal wealth management situation.

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