No one would disagree that our behavior affects the results we have in our finances, jobs, relationships or in our lives in general. Yet few people realize how irrational our decisions are, even when we believe our decisions are based on rational decision making. The central issue in behavioral finance is explaining why market participants make systematic errors. Such errors affect prices and returns, creating market inefficiencies. It also investigates how other participants attempt to take advantage of such market inefficiencies.
In 1979, Daniel Kahneman and Amos Tversky wrote the seminal paper in behavior economics, Prospect theory: An Analysis of Decision Under Risk, this important paper used cognitive psychology to explain various divergences of economic decision making from classical economic theory. Research indicates that the primary reasons for bad (irrational) decisions are; 1) an overconfidence in one’s ability or knowledge, 2) being sucked into a herd mentality, 3) over-reaction to news, which is the cause of bubbles and crashes, and 4) an irrational aversion to loss.
Why should you hire a professional portfolio manager?
There are many reasons you should consider hiring a professional to manage your portfolio, including relieving you of the time, hassle and stress of doing it yourself, access to investment choices only available to very large investors or institutional investors such as KeatsConnelly, and the availability of lower trading costs and mutual fund shares. However, we believe that the most important reason may be to help you avoid the common mistakes identified above.
Dimensional Fund Advisors (DFA) is an example of a mutual fund company that is only available through portfolio managers such as KeatsConnelly. The investment philosophy of DFA is based on the unbiased, empirical research of professors Eugene Fama, Kenneth French and Robert Merton, a Nobel Prize winner. Click here to watch a video made by DFA on behavioral biases. http://www.dfaus.com/2009/12/behavioral-biases.html A professional manager can help you avoid these common mistakes by sticking to a proven process and making decisions via an investment committee, rather than the emotional whims of one person.
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