June 2021 Issue: Providing Behavioral Alpha for Investments-Providing Behavioral Alpha for Investments by Linda Leitz

Providing Behavioral Alpha for Investments by Linda Leitz

Pdf Summary

Financial planners understand the importance of traditional alpha and tax alpha in investment performance. However, traditional finance assumes rational decision-making by individuals, which is not always the case in reality. Behavioral finance recognizes that people make mistakes and have behavioral biases that impact their investment decisions. This is where behavioral alpha comes into play.<br /><br />Behavioral alpha can be achieved by addressing three sources: superior information, superior information processing, and behavioral biases. While superior information may not be accessible to clients, planners can help clients process information correctly and avoid the negative impact of biases. Educating clients about the correct concepts through reliable sources can help them make informed decisions and trust their advisor's expertise over sensational financial media.<br /><br />Advisors can also help clients avoid behavioral missteps by addressing biases and emotional risks. Overconfidence, perceptions influenced by others' outcomes, saliency bias, representativeness bias, and anchoring bias are common biases that impact investment decisions. Advisors can provide information about potential negative outcomes, long-term trends, and the need for perspective to counteract these biases.<br /><br />Emphasizing process over personality is another important aspect. Well-organized practices with disciplined processes help advisors and clients stay on track and make decisions based on wisdom and intelligence, rather than emotions. Rules-based financial planning can be implemented where clients stick to mutually agreed-upon rules during difficult times, ensuring a consistent and thorough approach to financial planning.<br /><br />Educating clients, addressing biases, and focusing on a disciplined process can help advisors provide behavioral alpha for their clients' investments. It is important to guide clients with wisdom, intelligence, and a long-term perspective to help them achieve their financial goals while avoiding common behavioral pitfalls.

Keywords

financial planners

behavioral finance

behavioral alpha

superior information

educating clients

behavioral biases

investment decisions

emotional risks

disciplined processes

long-term perspective