Many of you have become accustomed to the BCM client newsletters that we send out quarterly, and now the blogs that are released more frequently and written from different people on our team. We are going to focus even more and have two of the weekly blogs a month written about behavioral investing and financial planning. These are two topics paramount to the values and purpose of our firm. Montgomery Gossen will be starting the “The Goals Based Planner” and will write about all things related to financial planning based on desired outcomes. I will be writing “The Behavioral Investor” blog, and it will focus on human behaviors (behavioral finance) and the emotional psychology that goes into the financial markets. The way the brain works and how it affects your net worth can be wild and extremely interesting! I hope you enjoy it as much as I do.
To start, what is behavioral finance and why has it gotten so much attention in the last few decades? Basically, behavioral finance is a sub-field of economics that combines traditional economics with the psychology of how humans make financial decisions. The purpose is to identify and understand WHY people make certain financial choices. Most investors continue to underperform the market over time. This means that the S&P is doing better than people who are ACTUALLY invested in the S&P; most of this “gap” is due to the fact that people buy and sell at different times (and it turns out most of these times hurt them more than know). Behavioral finance has been growing over the last twenty years specifically because of this fact–investors make illogical and often irrational decisions when it comes to investments.
In a textbook world of economics, humans are all perfectly rational, always weighing all the options to choose the very best outcome for their lives (including their stock portfolio). Most people would think that as technology increases and we have more data at our fingertips (smartphones, computers, etc.), we would also process all the information and maximize happiness/profitability.
Unfortunately (and no one wants to admit this), this is not how the story plays out. People are far from perfect and make illogical decisions all the time, mostly driven from emotions. We are often our own worst enemies because we are susceptible to mental mistakes and responses to short term news and trends in the stock market. I will go into more detail in later blogs, but these illogical decision-making behaviors can be called “investor biases” and hurt your portfolio returns. People tend to focus on short-term opportunities instead of sticking with a long-term, disciplined plan.
We have talked about something called the “behavior gap” in past newsletters but this concept is an important part of behavioral investing. Financial writer Carl Richards has coined the term “behavior gap,” which highlights the damage that we investors do to ourselves, due to bad investment behavior. This “behavior gap” is the real cost of losing discipline and not sticking to a well-designed, long-term investment plan. One of the greatest services a financial advisor can provide to clients (and we FOCUS on this DAILY) is helping to ensure that in times of market turbulence, processes and discipline outplay emotions such as fear and greed.
Please join me in the next few months as we dive into some of these topics. Some are more philosophical but all of them can apply to your life and your portfolio here at BCM. I will also write about what BCM does for you to “bridge the gap” in returns for your future success and peace of mind.
By Erin McMenemon