How Much Is Behavioral Advice Worth?

Abstract

Behavioral finance is a powerful tool when used effectively by investors and financial advisers. Although this usefulness is generally accepted in theory, the practical value of behavioral advice to investors has not been quantified to a large degree. The article provides a quantitative analysis of behavioral mistakes using a fictional case study of a private family that is making two key behavioral mistakes: loss aversion and mental accounting. First, these biases are explained, with examples. Next, the case study illustrates and quantifies investment losses due to behavioral mistakes. The key conclusion of the case study is that making behavioral mistakes causes investors to forgo returns, and this loss of return can be significant. However, if advisers and investors can recognize and correct behavioral mistakes, recouping or avoiding these gains is possible; these losses are not necessary. In sum, the value of behavioral advice is significant. TOPICS: Wealth management, long-term/retirement investing