Understanding Investor Behaviour

Abstract

When it comes to money and investing, we're not always as rational as we think we are – which is why there's a whole field of study that explains our sometimes strange behavior. Where do you, as an investor, fit in? Insight into the theory and findings of behavioral finance may help you answer this question. Behavioral Finance: Questioning the Rationality Assumption Much economic theory is based on the belief that individuals behave in a rational manner and that all existing information is embedded in the investment process. This assumption is the crux of the efficient market hypothesis. But researchers questioning this assumption have uncovered evidence that rational behavior is not always as prevalent as we might believe. Behavioral finance attempts to understand and explain how human emotions influence investors in their decision-making process. You'll be surprised at what they have found. The Facts In 2001 Dalbar, a financial-services research firm, released a study entitled "Quantitative Analysis of Investor Behavior," which concluded that average investors fail to achieve market-index returns. It found that in the 17-year period to December 2000, the S&P 500 returned an average of 16.29% per year, while the typical equity investor achieved only 5.32% for the same period – a startling 9% difference! It also found that during the same period, the average fixed-income investor earned only a 6.08% return per year, while the long-term Government Bond Index reaped 11.83%. In its 2015 version of the same publication, Dalbar again concluded that average investors fail to achieve market-index returns. It found that "the average equity mutual fund investor underperformed the S&P 500 by a wide margin of 8.19%. The broader market return was more than double the average equity mutual fund investorʼs return (13.69% vs. 5.50%)."