Does the key to successful investment lie in behaviour?

By Manos Panayiotou, advisor in Wealth & Investment Services at Hellenic Bank

Every day people struggle to balance logic and sentiment. Every individual needs to find the perfect compromise to satisfy heart and mind. As a result, many of the decisions people make are dictated by the heart and not the brain, and unfortunately when it comes to finance, sentimental decisions can sometimes be costly.

One of the decisions many individuals must face with both logic and sentiment is whether and how to invest? After all, investment is the sacrifice of spending in the present to potentially have greater spending power in the future. For example, someone needs to decide whether to buy that nice pair of shoes they saw online or invest the money to go towards their retirement. We all regularly find ourselves in that person’s shoes contemplating the financial sense of a purchase.

Manos Panayiotou

From a traditional financial standpoint, for the so-called Rational Economic Man (REM), investing the money rather than purchasing the shoes is a no-brainer. REM’s single mission is to maximise wealth.

Where traditional finance fails is in its ability to incorporate the fact that humans are not emotionless, self-interested robots. For example, people devote time and money to charity, are concerned with environmental, social, and economic issues and are willing to accept smaller gains rather than compromise their ethical and moral beliefs.

In response to the shortcomings of traditional finance, many studies and theories have emerged incorporating so-called behavioural finance. Some notable concepts and conclusions of those theories are:

• Losses weigh more than gains: The emotional impact of a loss on an individual is greater than an equivalent gain.
• Satisfactory is good enough: When it comes to financial decisions, people tend to go with a satisfactory decision rather than pushing for the optimal solution. This is attributed most of the time to the trade-off between time and cost.
• Presentation of information: Many financial decisions depend on the way the information is presented. For example, let’s assume that a hypothetical investment has an 80 per cent probability to return 8 per cent, and a 20 per cent probability to return -2 per cent in the first year. The following statements describe this situation:
  • This investment has an 80 per cent probability to return 8 per cent. On average, it is expected to return 6 per cent in the first year.
  • This investment has a 20 per cent probability to return -2 per cent. On average, it is expected to return 6 per cent in the first year.

Do the above statements have the same appeal, or would the first statement convince you to invest while the second statement might keep you from making this investment choice?

If finding the right investment sounds daunting and overwhelming,  these feelings are perfectly natural and might well be attributed to behavioural biases.

At the heart of behavioural finance for individuals are the behavioural biases that distinguish individual investors from the rational decision-makers of traditional finance. Have you ever come across someone that attributes all correct decisions to himself and all of the bad decisions to other factors? This is an example of a behavioural bias, namely the self-attribution bias.

The study of behavioural biases of individuals is helping advisors to better understand and respond to client reactions and needs. At Hellenic Bank we are aware of how these biases can become obstacles in reaching your financial targets.  Whether your goal is to build a nest egg for your retirement, or you want to invest for a better world, in collaboration with our strategic partners, Allianz Global Investors, we can help you navigate not only through the complexities of the investment world, but also through the very biases according to which you frame your decisions.