Practical Applications of How Much Is Behavioral Advice Worth?

Practical Applications Summary In How Much Is Behavioral Advice Worth? in the Fall 2019 edition of The Journal of Wealth Management, Michael Pompian of Sunpointe Investments, LLC, quantitatively analyzes behavioral mistakes by investors through a case study of an affluent family that commits two common ones: loss aversion and mental accounting. The author explains how such fundamentally irrational behavior, often driven by fear and the temptation to limit losses by selling during sudden market downturns, can be detrimental to overall long-term returns. Behavioral finance—the study of how psychology affects investors, analysts, and the overall market—has gained relatively widespread acceptance over the past 20 years. Yet many investors and advisers remain vulnerable to psychological pitfalls and may be uninformed about how wealth management strategies might incorporate behavioral advice. Pompian uses his case study to emphasize the importance of recognizing psychological biases and to illustrate how they can drive mistakes that reduce investment returns. He asserts that advisers who understand behavioral finance can help investors, especially wealthier ones with more complex investment needs, avoid needless risk.