Behavioral Finance and Investing in the News

Oct 24, 2014
Behavioral Finance, Research, Investing, Stocks, Current Events

Interesting reads to help your students understand the importance of understanding what drives our investing behaviors:

  • What are the ten commandments of investor behavior (ThinkAdvisor):

“Something similar is afoot in financial services today,” said Crosby, who is also president of IncBlot Behavioral Finance, during a Wednesday session at FSI’s Financial Advisor Summit. “We now know because of behavioral finance in the last 40 or 50 years of research, we know that some of the greatest good that an advisor can do is hold the hands of their clients, to manage their behavior.”

As evidence, Crosby pointed to how the market over the last 30 years has returned 11.1% a year while the average investor has held onto less than 4% “because of their bad behavior.”

  • What drives your level of risk tolerance?  It’s all in your head, I mean brain (Wall Street Journal).

Increasingly, scientists are tackling the problem. A new study, just published in the prestigious Journal of Neuroscience by a team of researchers at University College London, the University of Sydney, the University of Pennsylvania, New York University and Yale University, found that the density of cells in one region of the brain predicts how willing people are to take financial risk.  This research appears to “provide the first link between brain structure and risky choice,” says neuroscientist Scott Huettel of Duke University, who wasn’t involved in the study.

  • The importance of rebalancing your portfolio and how it flies in the face of human nature (Forbes):

In fact, a rebalancing discipline is very much a struggle against human nature. In basic terms, it forces investors to buy low and sell high. That sounds like wise investing, but we know from behavioral finance research (for instance, loss aversion, wherein humans feel losses twice as powerfully as equivalent gains) and from experience in the trenches with investors that most people are afraid to invest in assets that have recently experienced steep losses or to sell winners that appear to be rising in value. That’s just how we’re wired: Rebalancing runs counter to our instincts. Note the difference between a naïve buy-and-hold strategy, with no trading or rebalancing, and the long-horizon investing strategy that I am describing. Rebalancing requires a continual process of buying and selling assets over time to return strategic allocations to predetermined levels. This typically will involve investing cash flows, such as monthly savings, into underweight assets.

  • How does your personality impact your investment choices (Morningstar)?

Durand and two colleagues concluded in a Journal of Behavioral Finance article that personality traits are associated with a wide range of investment decisions and outcomes. The research for that article and Durand’s ongoing research is based on the 5-factor model of personality traits (Big Five), which is the leading paradigm in personality research. It’s an efficient model because it dismisses hundreds of personality traits in favour of the “Big Five“.

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.