It’s very easy to get caught up in the headlines and wonder about the impact on your portfolio: When are interest rates heading higher? What’s the next move for oil prices? Will Europe slip back into recession? Investors frequently read these stories then form strong opinions about what’s going to happen next. As the field of behavioral finance indicates, however, our emotions habitually lead us in the wrong direction when it comes to investing.
Behavioral finance represents the intersection of economics and psychology and seeks to explain why people make financial decisions often times irrationally. Our most recent book, Nonprofit Investing: Effective Investment Strategies and Oversight (Wiley & Sons, 2012), details several concepts and biases. Many of these concepts such as anchoring, herd behavior, confirmation and hindsight bias, among others, can be very real and we’ve all likely fallen prey to these at one time or another. They can subconsciously influence our thought process and decision-making.
Data from the most recent Dalbar study on investor returns suggests that the average investor’s performance significantly lags that of major stock and bond indices over time, most likely because biases lead to poor timing and selection in investment decisions (Figure 1).
