Overcoming the cost of being human

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It is easy to talk a good game about investing. Views can be two-a-penny: from idle cocktail-party chatter to the latest pop-scientific bestseller whose author beat the market ‘and can show you how!’

However – although the guiding principles of good investing have been known for decades – evidence suggests that most investors do considerably worse than they could if they adhered to a few simple principles. And it seems that being human doesn’t help.

Behavioural finance matters 3 of 10 Introduction 1 of 10

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Our innate need for emotional comfort is estimated to cost the average investor around 2–3% per year in foregone returns 1. For many, the figure is much higher. This shortfall – referred to as the behaviour gap – stems from the fact that the financial decisions that are optimal for the long term are often very uncomfortable to live with in the short term.

The classical principles of good investing are based on the assumption that we are all perfectly calm, unemotional beings, concerned only with long-term financial objectives and, therefore, stick staunchly to the following four principles of good investing:

  • Put your wealth to work (being invested),
  • Diversify to reduce risk (spreading your risk across markets, asset classes, geographies and industries),
  • Ensure you have sufficient liquidity to withstand the journey (avoiding being forced to sell at a time not of your choosing), and
  • Rebalance (selling asset classes that have risen in value, and purchase those that have fallen, in order to continually buy low, and sell high over time).

This model is neither new nor complex, but to be able to stick at it, investors must be emotionally comfortable enough to (a) enter the market, and (b) stay in it.

“This dynamic, new discipline combines psychology with financial theory to understand the interplay between markets and our emotions, personality and reason.”

In truth, as human beings our emotions are the biggest driver of our investment decisions and, therefore, our returns. In turbulent times, theory often goes out the window. Depending on the market cycle and how it makes us feel, we may leave large portions of our wealth un-invested; we may be overconfident and overactive with the portion that we do invest; and, in the end, we often give in to our strong psychological tendency to buy high and sell low.

Behavioural finance – an emerging field in the investment landscape – seeks to help investors find a middle ground. This dynamic, new discipline combines psychology with financial theory to understand the interplay between markets and our emotions, personality and reason.

Barclays is unique within the industry because our dedicated team – comprising economists, psychologists and behavioural scientists – has been working with investors since 2006 to actively narrow the behaviour gap. We use ideas from behavioural finance to improve our understanding of your needs, and turn this understanding into practical solutions.

In this white paper, we discuss what your emotions could be costing you, and outline how we can work with you to purchase the emotional comfort required to transform your investment journey and, more crucially, achieve potentially better results – by helping you stick to an investment programme over the long term.