Financial Education

Behavioral finance suggests that investors are loss averse, hold biased expectations and segregate assets. To accommodate behavior, portfolio construction should allow for both objective and subjective constraints. In addition, an integrated portfolio can be formed from layers of segregated assets.

Loss aversion means investors do not view risk as uncertainty but rather as the potential for gain or loss. Investors tend to place more weight on losses than on gains, and will actually seek risk to avoid a certain loss but avoid risk to achieve a certain gain, even when probabilities favor the opposite course of action.

Biased expectations arise from overconfidence about ones predictions of future outcomes and from overestimating the significance of rare events.

Asset segregation, or mental accounting, tends to consider different assets according to purpose or preference. The interaction between investments is often ignored.

For more information, see all articles on: Behavioral Finance, FInancial Planning, Portfolio Management

See also:

What is Behavioral Finance?

Escalation Bias

Prospect Theory

How Psychological Profiling Can Be Used to Understand Individual Investor Behavior

Overconfidence and Confirmation Bias