Behavioral Finance might sound a little esoteric and perhaps like it’s a subject for grad school. But the question this scientific field tries to answer is actually quite simple: why do investors, even experienced ones, often make misguided choices? Icon uses the principles of Behavioral Finance to ensure its plan participants are successful in saving for retirement.
What Is Behavioral Finance?
Behavioral Finance is a field of study that was developed in the 1980’s and 1990’s in response to what experts thought were unpredictable moves in the stock market. At the time, the Efficient Market Hypothesis held that the stock market moves in predictable, rational ways because everyone has access to the same public information (and those that have access to insider information aren’t allowed to trade on said information).
But the stock market often moves in irregular or volatile ways so researchers wanted to find out why.
What Has Research Into Behavioral Finance Found?
In short, Behavioral Finance has found that the markets don’t always move in predictable, rational ways, because the people who are operating within those markets (i.e. the investors) are not always rational and predictable. Instead, they often let outside psychological influences affect their investment decisions.
Some of the phenomena researchers have found include:
- Stocks with ticker symbols starting with an A, B, or C are traded more often and are thus considered more liquid than those with tickers starting with X, Y or Z.
- Investors (even experienced ones) have a tendency to sell winners too quickly and hold losers too long. Presumably because the pain of losing is greater than the satisfaction of gains.
- Most actively managed funds (i.e. those managed by a broker who decides which assets to buy and sell) don’t beat passively managed funds (i.e. those that are automatically rebalanced using an algorithm).
Reasons for this behavior include several biases:
- Herd behavior: the instinct to act how others act.
- Overconfident bias: you think you know more than you do.
- Hindsight bias: you think what happened before will happen again.
- Confirmation bias: you look for information that confirms what you already think is true.
- Anchoring bias: basing your assessment of value on the numbers in your immediate vicinity. A real world example of this is: you live in an area with a high cost of living, so you think that everything costs more than it does (or should).
How Does Icon Use Behavioral Finance To Make You More Successful At Saving For Retirement?
Icon asks you a few questions to understand your financial situation. Then, we use an algorithm to determine the assets your portfolio should include. We use an algorithm to rebalance your portfolio regularly to ensure you always own the asset mix that makes sense for your financial goals and timeline.
Why do we use an algorithm? Because an algorithm doesn’t have psychological biases. It doesn’t favor stocks with tickers at the beginning of the alphabet or have hindsight bias.
We also don’t use jargon to influence your decisions. And we show gains and losses in true dollar amounts instead of percentages because it’s an easier way for people to understand the state of their portfolio.
At Icon, our goal is to help you save for retirement successfully. We don’t make money off of the sale of specific assets nor are we motivated by having as many assets under management as possible. We are simply motivated by closing the retirement savings gap because we believe everyone deserves a financially secure future.