Why Have a Financial Advisor?

Consider all of the complex financial decisions faced by investors today. Without experience in different market environments or knowledge of market history, how might many of these investors make their financial decisions? Potentially through their perceptions or based on their emotions. *According to financial thought leader Nick Murray, over 20-year periods the average equity investor will do himself out of nearly 60% of the return by fairly common and predictable behavioral mistakes. For this reason it is imperative that investors have a financial guide to help them understand and combat the myriad of illusions they may be prone to.

Overconfidence: Rating oneself as above average when it comes to selecting investments.
Implications:

Miscalculating the probability of good outcomes
Focusing on the potential upside of investments
De-emphasizing the potential downside of investments

Hindsight bias: Believing that unpredictable past events, in retrospect, were obvious and predictable.
Implications:

Feelings of anger and regret
Failure to avoid what appears to have been foreseeable
Overconfidence

Short-term focus: Inappropriately focusing on short-term risk versus long-term risk.
Implications:

Miscalculating the probability of good outcomes
Focusing on the potential upside of investments
De-emphasizing the potential downside of investments

Regret: Having illogical feelings of guilt because of a poor outcome.
Implications:

Investors’ future investment decisions might be affected
Can cause investors to become more risk adverse/risk tolerant
These individuals may blame advisors for perceived mistakes

Mental accounting: Mentally compartmentalizing investments while ignoring the aggregate portfolio.
Implications:

Investors tend to disaggrega te a diversified portfolio
Risk and return components viewed in a vacuum
Leads to heightened concern about the riskiness of a component of a portfolio

Hot-hand fallacy: Perceiving trends where none exist and consequently taking action on this faulty observation.
Implications:

Investors desire to invest in last year’s winners
Favoring a “hot” money manager or asset class
Skill is inferred from a random pattern of chance
Can lead to erroneous assumptions and predictions