Investing can be highly stressful.  Sometimes the statistically “correct” move will seem counterintuitive.  It will conflict with an investor’s gut instinct.  Even the Nobel Prize winning economist, Harry Markowitz, who is considered one of the founders of Modern Portfolio Theory, found it difficult to implement his theories into practice in his own portfolio. 

It is psychologically very difficult to sell those investments that have been doing so well (think of tech stocks in the late 90’s) and to buy underperforming investments (such as REITS(1) in the 90’s).  Turning these decisions over to someone else is one way to help overcome the natural tendency to stick with the “winners” and avoid the “losers.”  The financial media may also play an unhelpful role by focusing attention on what may seem like hot business news, rather than offering meaningful or valuable market analysis. This is particularly true for TV, which can seem to be more in the business of entertainment.

Behavioral Finance is a field that recognizes that humans are influenced by emotions, rather than always acting “rationally” as assumed in many economic and financial models.  It can be useful to understand how emotions can bias our investment decisions.  For example, investors often fixate on the price they originally paid for a stock, and may hold on to that stock against all reason until it returns to that level. 

For those interested in better understanding how emotions effect decisions, a new field, sometimes called Neuroeconomics, which explores the intersection of Neuroscience with Behavioral Finance, has been receiving a lot of attention. It attempts to provide a scientific explanation for seemingly “irrational” investment decisions.  A recently published book, Your Money and Your Brain by Jason Zweig offers a very readable synopsis of this evolving field.

Successful investors commit on a long-term plan from which they do not waver.  This is one of the benefits of having an Investment Policy Statement.  In times of market volatility it provides a calming reminder of one’s long-term strategy.  Assumptions should of course be reviewed periodically or in response to changes in one’s own circumstances.  An independent investment advisor can provide a good counter-balance to an investor’s own gut reactions to market movements either on the upside or the downside.

(1)REITS (Real Estate Investment Trusts) is a type of corporate structure that invests in real estate.  REITS, which come in several varieties, have a special tax structure.