BEHAVIOURAL FINANCE IN PRACTICE

BEHAVIOURAL FINANCE IN PRACTICE

• Role of Emotions in Goal Setting: Emotions play a significant role in goal setting, and investors often make decisions based on emotional triggers. Understanding these impulses is crucial for investment advisers to provide effective guidance.
• Nudging the Investor to Behave Better: Investment advisers can help clients make better decisions by laying down advance ground rules and providing built-in nudges, such as asset rebalancing, to encourage rational behavior.
• Role of Investment Adviser in Management of Client Emotions: Investment advisers play a vital role in managing client emotions, helping them navigate market cycles, and making informed decisions despite emotional upsurges.

Key Concepts in Behavioural Finance

• Retail Therapy: A stress-reducing behavior where individuals indulge in shopping sprees, which can be managed by setting a specific budget and imposing self-limiting measures.
• Action Bias: The tendency to take excessive actions, leading to frequent transactions, which can be mitigated by educating clients on the benefits of patience and long-term investing.
• Chasing Past Performance: Investing based on past performance, which can lead to poor decisions, and can be avoided by implementing a pre-decided asset allocation policy.
• Home Country Bias: The preference to invest in domestic securities due to familiarity, which can be addressed by educating clients on the benefits of global investing and providing access to international investment opportunities.
• Buying Insurance for Tax Saving: The practice of purchasing insurance solely for tax benefits, which can lead to inadequate insurance coverage, and can be corrected by highlighting the importance of pure insurance products.
• Over-Diversification or Concentration: Having too many or too few securities in a portfolio, which can be optimized by finding a balance based on the client's risk profile and goals.
• Framing and Risk Tolerance: The impact of framing on risk tolerance questions, which can influence client decisions, and can be addressed by understanding individual preferences and using appropriate framing techniques.
• Overconfidence and Risk Management: The tendency to overestimate one's abilities, leading to overconfidence and poor risk management, which can be mitigated by the investment adviser's objective guidance.