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Behavioural Finance for Everyday Investors
We like to think we invest rationally, but the field of behavioural finance has shown there are social, emotional, and even cognitive factors that can affect our investing decisions. By becoming aware of these unconscious tendencies, we have a better chance of meeting our long-term investing goals.
Loss aversion occurs because we're wired to feel twice as bad about a loss as we feel good about a gain. Volatile markets can tempt an investor to forego future opportunities rather than face the possibility of a loss. And that may cause long term goals to fall by the wayside.
Is loss aversion making you lose sight of your long-term goals?
If you could build the world's ultimate soccer team, chances are you would choose the best players from around the world.
But what does soccer have to do with investing? It only makes sense that the best companies, like the best players, are going to come from different countries.
Home country bias may be limiting your opportunities. So, as you draw up a strategy for the right mix of investments, maybe you need to consider adding more international players.
Is supporting the home team costing you money?
The odds of being attacked by a shark in the U.S. are said to be about 1 in 11,500,000. The odds are clearly stacked in our favour.
While our rational mind knows shark attacks are rare, if there's information available to us that's not only more recent, but more traumatic, it's likely to have a stronger influence on our decisions. This is called "availability bias".
Let's talk about sharks
Herding is the idea that people are more comfortable investing their money in the same way as the majority of others at any given time.
Simply put, it's relying on the wisdom of the crowd—even when the crowd may be doing something kind of nutty.
Are you investing to meet your own goals or just following the crowd?
Talk to your financial advisor. It is a great way to take a step back and get an objective opinion. Are you investing to meet your own goals or have you let loss aversion limit your opportunities? Your advisor can help you stay focused on your long-term goals and the financial plan you've created to meet them.