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Behavioural finance seeks to explain money mindsets

By Ruan Jooste’s Rants and Cents

 

Legendary investor and CEO of Berkshire Hathaway, Warren Buffett turned 93 this year, and according to Forbes, he is worth $106 billion. That means on average meaning he’s earned over $3.5 million every day of his life. Much has changed during his tenure, but he has always been consistent in his opinion, that “investing is simple, but certainly not easy.”

Behavioural finance seeks to explain money mindsets

Former Personal Finance editor Bruce Cameron and Wouter Fourie, CEO of Ascor Independent Wealth Managers, wrote in their book The Ultimate Guide To Retirement, that “the mere act of investing one’s money can be daunting, and if you add the movements of the markets, the glut of news and advice, and the general human condition, it can be downright crazy”.

“Unfortunately, if we do not try to understand why the markets act the way they do, we can lose out on potential gains, or even worse, we can lose money and miss our investment goals altogether,” they wrote. That is what a concept called Behavioural Finance seeks to address.

Behavioural Finance describes the study of human behaviour through the use of systematic experimentation and observation, and would you believe that scientists have identified more than 50 unique ways in which investors’ emotions influence the way they invest? They are called “systematic biases”. This includes being too confident in your choices, placing too much emphasis on recent returns, and even underestimating the power of compound interest.

At the end of the day, investment isn’t just about the numbers; it’s about the people behind the numbers. It’s also about understanding why the people behind the numbers act as they do.

I attended a Momentum Investments webinar this week, in association with the CFA Society of SA and the Global Association of Applied Behavioural Scientists on the Future of Behavioural Finance, where on the one hand, they were talking about the human “empathy” economy where physiology is playing a more important role in solving our problems. On the other hand, the discussions were around the era of artificial intelligence and quantum computing, which is showing tremendous opportunity and uncertainty.I’m not even going to pretend that I understood the second - more technical - part of the conversation with the algorithm this and machine learning that. But what I can tell you is that these intricate models can capture complex interactions between cognitive bias and market dynamics, providing more nuanced predictions for investors. After all, behavioural finance analysis evolves and revolves around understanding how emotions and cognitive biases impact investment decisions. For instance, investors often hold losing positions rather than feel the pain associated with taking a loss.So in layman's terms, if you can arm yourself with some relatively simple concepts and an understanding of behavioural finance and how people act, you can make better investments and potentially life-changing financial decisions.

The CFA Society has, for instance, identified four personality types when it comes to money and investing, and are unpacked in “The Ultimate Guide to Retirement in SA” as follows:

  • Preservers:

  • Accumulators:

  • Followers:

  • Independents:

And as the book’s short list of financial biases shows, people make decisions on the basis of deep-rooted belief systems. And that is where the key role of the financial planner comes in.

A good financial adviser can counterbalance your own personality type and help you keep focused on your long-term investment goals.

And to quote the Ultimate Guide to Retirement in SA for the final time:“For preservers, planners can help them stretch beyond their safe environment of knowing investment options. For accumulators, they cannon on the brakes when the need for wealth accumulation overwhelms common sense. For followers, they can be the voice of reason, and for independents, they can offer alternative insights and guidance. “Most importantly, certified financial planners are registered service providers and regulated by both the Financial Advisory and Intermediary Services Act and the new outcomes-based regulatory regime called Treating Customers Fairly. So they are compelled to act professionally at all times and trained to rationally justify the decisions they make and the advice they give. That is a bit more than I say for ChatGPT.

This article was first appeared on https://www.iol.co.za/personal-finance/opinion/ruan-joostes-rants-and-cents-behavioural-finance-seeks-to-explain-money-mindsets-b7d328c4-3dfc-4aa5-a543-683c18f950fd.

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