The Psychology of Investing
To put it bluntly, humans seem to be hardwired for investment failure and those who are successful are either lucky or have been able to overcome their tendencies to fail.
Most of us know people who never have any money and carry the maximum debt possible. Then we know people who always have some money but never very much. A smaller number of people are well off and an even smaller number of people are wealthy.
Clearly it is possible to become wealthier and to learn how to become wealthier.
The mechanics of accumulating wealth are simple - spend less than you earn and invest the difference well.
The psychology of investing is hard - a whole branch of economics called behavioural finance concerns itself with the interaction of psychology and investing.
A report by Dalbar, Inc, an American research company, puts it this way:
Investment return is far more dependent on investor behaviour than on fund performance. Mutual fund (investment fund) investors who hold their investments are more successful than those that time the market.
Principles of behavioural finance
QAIB (a branch of Dalbar, Inc) applies the principles of behavioural finance to provide measurements and insights into what mutual fund investors really do, what is in their best interest and what it costs them.
The table below shows a list of the most common mental errors investors make.
Loss aversion | expecting to find high returns with low risk |
Narrow framing | making decisions without considering all implications |
Anchoring | relating to familiar experiences, even when inappropriate |
Mental accounting | taking undue risk in one area and avoiding rational risk in others |
Diversification | seeking to reduce risk, but simply using different sources, eg 3 different resource stocks |
Herding | copying the behaviour of others even in the face of unfavourable outcomes |
Regret | treating committed errors more seriously than errors of omission |
Media response | tendency to react to news without reasonable examination |
Optimism | belief that good things happen to me and bad things happen to others |
Financial advisor role
QAIB shows that investment returns increase when the natural characteristics listed above are replaced by disciplined investment behaviour. While many investors can overcome these hurdles, most need the support of a financial advisor to supply the required discipline.
One of the most important roles of the financial advisor is to protect clients from the behaviours that erode their investments and savings.
The following quote is in a similar vein:
"Remember that good advice is valuable, and when the going gets tough, simple hand-holding by an adviser which prevents short-term mistakes may be the most valuable service that the adviser provides."
| Peter Stanyer in "Guide to Investment Strategy", published by |  |
Providing clear and up-front financial knowledge -
so that you are truly served by being completely informed.
