Behavior of the Much of the basic
individual investor has theories of behavioral
long been the interest finance concern
of academics and irrational or
portfolio managers, but overconfident behavior
not investors as it relates to the
themselves. The herd so-called rational
mentality sometimes investor.
dominates over reason,
but why? Ask Dr. Daniel Dr. Kahneman, who
Kahneman, the Eugene recently spoke in New
Higgins Professor of York City at the Wealth
Psychology at Princeton Symposium co-sponsored
University, about by the Institute of
investor behavior, Certified Financial
however, as it relates Planners and Warburg
to risk or loss aversion Pincus Investments, is
and some fascinating famous for his original
concepts emerge. works on the concept of
“loss aversion”, a
Investor behavior is phrase he developed that
part of the academic is widely used today in
discipline known as the investment
“behavioral finance”. community.
Loss aversion describes the optimism to win the
the basic concept that, $15,000.
although the average
investor carries an How does this effect
optimism bias toward trading? Most investors
their forecasts (“this think they can beat the
stock is sure to go market (overconfidence)
up”), they are less although evidence is
willing to lose money overwhelming that they
than they are to gain. cannot. An associate of
Dr. Kahneman, Terry
An example: Would you Odean studied the
accept this gamble? A behavior of buying and
“50 percent chance to selling stock. His
win $15,000” or a “50 findings point out that
percent chance to lose “when an investor sells
$10,000”. Most people a stock and immediately
would reject this gamble buys another, the stock
as too risky. The that is sold does better
aversion to lose the in the following year,
$10,000 is greater than by 3.4% on average”.
Selling at the wrong and foreign, you should
time brings about the continue on this course.
concept of “regret”. Buying tech stocks or
Feelings of regret also emerging market funds
come about in situations may be out of character
of “hindsight”, (“I for you. Following a
should have bought AOL routine will provide
last year”) and “coming greater satisfaction as
close”, (“I was all set well as a mechanism for
to buy AOL last year controlling regret.
when I was unexpectedly 2. Make a Decision
called out of town”). Hindsight-Proof: You can
avoid second-guessing by
How can investors deal thinking a lot about the
with these real decision before acting.
psychological issues? The idea that a purchase
Professor Kahneman must be made ''now'' is
suggests that regret, usually nonsense. Good
optimism, and risk stocks are long-term
taking can be controlled buys and they are,
by; therefore, rarely
1. Follow a Routine: If subject to any
you have been short-term
comfortable with decision-making. Again,
diversifying your assets following a routine is
among various asset helpful in the decision-
classes both domestic making process.
Dr. Kahneman also the average investor
pointed out that people panics in a market
are prone to “cognitive downturn, a time perhaps
illusions”, like to buy rather than sell.
becoming rich and famous
or being able to get out
of the market before a
bubble breaks. People
exaggerate the element
of skill and deny the
role of chance in their
decision-making process.
People are often unaware
of the risks they
take.
Add loss aversion to the
mix and it's no wonder
