As published in the Shore 2015 Edition of NJ Lifestyle
Traditional finance has long held to the notion that investors are rational, unbiased, and risk averse. It also professes that investors’ comfort level for risk is essentially stable and individuals will only accept higher levels of risk if offered adequate returns. Many of us have learned from real world experience that this is not always true. To explain the realities of investing a new field of study has emerged, behavioral finance. The new discipline portrays investors as being regularly overconfident, chronically emotional, and habitually biased.
There are many psychological propensities leading to investment missteps identified in the behavioral finance literature. This article discusses three axioms that can be used to illustrate how psychological factors can cause investors’ mistakes that lead to market inefficiencies. By understanding the tendencies and biases of human nature, we will be better able to avoid them and generate better investment results.