Investors do not always act rationally. As humans they often respond emotionally to unexpected events.
Most traditional finance theories assume that people will act rationally, considering all available information when they make investment decisions. But behavioral finance challenges that assumption. Everyone may know what to do and have a plan in place but following that plan and abandoning your emotions is often a difficult task.
The human brain processes all sorts of emotional stimuli, including fear, greed, euphoria, grief, pain, and pleasure. While a modern-day computer could process the information in nanoseconds, in a logical and rational fashion, the human brain often responds to emotional stimuli in an irrational manner. This is where we see the punter behavioral biases in humans coming out.
Loss aversion. Investors will go to great lengths to avoid losses. Consequently, they may fall short of their goals by being conservative.
Confirmation bias. People are often drawn to information or ideas that validate their beliefs and opinions. This bias can hurt investors, who should objectively evaluate a strategy or investment product.
Mental accounting. This occurs when a person views some money sources as different from others—for instance, money you’ve earned versus money you inherited.
Illusion of control bias. This occurs when investors believe they can pick individual stocks or managers that will outperform. They believe that because they are in control, the outcome will be better.
Recency bias. Many investors are prone to chasing hot stocks, asset classes, and asset managers. They see strong recent results and extrapolate those results into the future, which rarely works out in the long run. In some instances, investors tend to chase the hot stocks even after the bull run.
Hindsight bias. This occurs when investors say (after the fact) that they knew a particular stock or investment would fail. Both investors and advisors tend to overstate their abilities to predict the future, which can lead to excessive risk-taking.
Herd mentality. Although many people pride themselves on thinking independently, humans are social animals and often do what others have done. Investors may chase popular stocks for fear of missing out.
Investors should know about the status of their financial markets, their asset allocation, and most important stay calm emotionally. We are all prone to responding to emotional stimuli and should recognize the challenges, we as investors face in overcoming irrational impulses. Be Assured, We Are Not Alone In This.
These biases are a hinderance to your financial well-being. A Financial Advisor undertakes responsibility to transform you from a Punter to a Planner and can add considerable value by embracing the role as a behavioral coach.
Financial advisors are more than just "money experts". They act as a voice of rationality to their client's goals and situations. By fusing together, the financial and emotional aspects of a client's life, a financial advisor can craft a large-scale investment plan.
The value of financial advisors is heightened during periods of economic uncertainty when clients may be most fearful, and markets aren't invoking confidence. Their systematic reviews, periodic rebalancing, proper asset allocation, and spending plans are all examples of behavioral coaching. This helps investors make financial decisions in an ordered, rational fashion, rather than reacting to news about the stock market or the economy. The best financial advisors play a number of roles such as investment manager, relationship manager, or even entrepreneur.
MIMI PARTHA SARATHY
Sinhasi Consultants Pvt. Ltd.
Financial advisors bring a process-oriented approach to their clients’ financial plans. They help to shape their clients’ behavior. Their length of time in the industry will provide the benefit of historical expertise. Not every investor has weathered a recession or a “Black Swan” condition impacting their portfolio.
The longer a firm has been in business, the more historical knowledge they have, of previous downturns and what strategies can be deployed today.
The key trait that the best financial advisors share is that they are outstanding listeners. They take the time to sit down with their clients and prospects and understand their concerns, hopes, and goals: How do they feel about money? What financial issues keep them awake? What do they want to achieve? It’s important to have a baseline for each client. Understanding their concerns, goals, and fears is a starting point from which they help steer the client’s financial behavior towards being a Planner rather than a Punter. Have you taken the time to discuss these with a Financial Advisor who can give your money the opportunity to grow and help you work towards your other life goals?