Personal Benchmark: Integrating Behavioral Finance and Investment Management

Chapter 2Investor Emotions and Financial Decisions

Dr. Daniel Crosby

Money can get rid of your financial problems, but it won't get rid of your emotional problems.

—Sonya Parker, author

To truly understand the nature of the Personal Benchmark solution, it is helpful to first understand its underlying theory. A traditional investment product typically relies on one, two, or three schools of thought. These include Investment Theory, Risk Theory, and Economic Theory. We will discuss all three in some detail in Chapter 4. But for now we will discuss something more unique. At its core, Personal Benchmark was developed with deep reliance on the multi-disciplinary study we know as Behavioral Finance: The idea that our financial decisions and behaviors are not fully rational.

Behavioral finance has risen to the public consciousness through at least three primary channels: an academic spat with traditional finance, a collection of pithy anecdotes about human irrationality, and an explanatory framework for a series of recent financial catastrophes beginning with the dot.com bubble and ending with the Great Recession. This chapter provides an overview of this field, including its origins, what behavioral finance is and is not, and how these concepts are applied to the everyday work of financial advisors.

The Origins and Evolution of Behavioral Finance

Behavioral finance sits at the crossroads of finance, economics, psychology, social psychology, decision-making science and neurology, ...