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Psychoanalysis meets investing

Even if you are only an occasional reader of trade publications, you cannot have escaped one of the hottest buzz phrases in our industry behavioural finance where the worlds of psychology and financial theory have collided to form a burgeoning new field of study.

In a nutshell, behavioural finance, or behavioural economics, is the study of why investors think and do what they do about money and inv-esting. The unflattering results show that investors can be irrational, emotional and, at times, downright dysfunctional.

The experts correctly question illogic such as what compels a person to drive 30 minutes to use a 1 voucher or wash their own car to save 5 but never dream of washing their own neighbours car for 5. Or indeed, why the same person who would never buy the most expensive orange juice at the supermarket has no trouble plopping down 5 for a venti, half-caf, breve latte.

But let us suppose you have done your homework and poured over the works of Hersh Shefrin or the extensive research of Dr Shlomo Ben-artzi. If you have, you have probably reacted as a patient who has finally been given, after years of suffering, the clinical definition of his ailment. So, what does it mean doctor? is the typical reaction.

So, what does all this great description and explanation of human and investor behaviour mean with respect to what the typical investor should do? This question is where the bulk of the behavioural finance literature seems to leave us hanging. Ask another question of how you can use behavioural finance to help your clients avoid some of the most common financial missteps.

Dont try this aloneThe world of investments is complicated enough. Just und-erstanding investment products is complicated. Research shows that, left to their own devices, investors make a multitude of mistakes. They do not properly allocate assets, they overload their portfolios in a given sector or company, often with their own employers stock. They buy when they should sell and sell when they should buy. They are overly-influenced by the trend du jour.

The greatest lesson that investors can take away from behavioural finance is that they need the services of a finan- cial professional. Just as the typical patient would be considered foolish to attempt brain surgery on himself, the typical investor is equally lost in this complicated world.

Help investors by illustra-ting how you can help them establish goals, allocate assets, implement a long-term stra-tegy, monitor progress and, perhaps most importantly, provide an objective view- point to help investors overcome the fear and emotion which often drives the investment decisions.

What you dont see can help youCollection in advance (that is, straight from salary) can help your clients become disciplined savers. An automatic investment plan allows clients to pay themselves first. Their investments are treated as another part of their regular budget and rather than spending extra income on impulse an automatic investment plan, forces investors to put more money away over the long run.

Do not peek stay focused on the long termBehavioural finance teaches us that one of the best ways you can help a client is to explain the importance of asset allocation, automatic rebalancing and, above all else, a long-term perspective. Encourage your clients to stop looking daily at account balances and market fluctuations.

Maximise qualified contributionsWould you turn down free money? Of course not and neither should your clients. Behavioural finance research shows that investors do not treat their pensions the same way they do their other investments. As an adviser, one of the best ways you can help clients meet their long-term financial goals is to recommend that they first contribute the maximum amount allowable to their employer-sponsored retirement plans.

Regularly increase your savings rateInflation eats away at our savings. To help combat this inc-reased cost of living, one of the best pieces of advice you can give clients is to increase their savings rate.

The value of behavioural finance for advisers is not about understanding complex psychological theory, it is in understanding your clients better and helping them take a more common-sense approach to investing. Keeping your clients on track may take some tough love but as an adviser you sometimes need to protect your clients from themselves.

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