Behavioral Finance and Your Portfolio

1What Is Behavioral Finance and Why Does It Matter?

People in standard finance are rational. People in behavioral finance are normal.

—Meir Statman, PhD, Santa Clara University

If you are reading this book, you have decided that building the best portfolio for you, your family or your organization requires a solid understanding of human behavior. And the most important human behavior to understand is your own! After all, you need to make the best financial decisions possible and this requires understanding how you behave when money is involved. After advising individuals and families for over 25 years on their investment portfolios, and now running my own investment firm, I have found that understanding and applying behavioral finance to the investment process is the absolutely best way to manage portfolios for long term financial success. It may be counter-intuitive, but unless one has super-human capabilities to know which direction the markets are going all the time, the best strategy for managing a portfolio is to choose a comfortable level of risk and stick with that strategy. The less tinkering the better! Does this mean you don't pay attention to it? Of course not! Investors need to pay attention to the value of assets they own, the structural changes in companies or industries that occur, portfolio rebalancing points, etc.—but the core asset allocation framework should remain the same unless personal circumstances have changed. So why is it so hard for investors to ...