Behavioral Finance

Episode 27 of The Smarter Money Show explores behavioral finance, revealing how psychological biases like loss aversion and herd mentality lead to costly investing mistakes. It highlights how emotions drove market events like the 2008 financial crisis, where panic selling cost investors a 300% recovery by 2019.

A 2021 Dalbar study shows emotional decisions caused a $400,000 shortfall for the average investor over 30 years. The episode offers strategies like creating a written investment plan and automating contributions to ETFs like VOO to stay disciplined. A step-by-step plan helps listeners identify biases, diversify portfolios, and seek objective advice to build wealth rationally.

Episode Transcript

Speaker 1 (00:00):
As always before we begin, this podcast is for informational
and educational purposes only. It is not financial advice. Always
do your own research and consult with a licensed advisor
before making any investment decisions. Welcome back to the Smarter
Money Show. I'm your host, and this is episode twenty seven.
Imagine this. It's March twenty twenty. The stock market is

(00:21):
plummeting and your portfolio is down thirty percent. Your gut
screams to sell everything, but a year later the market
rebounds fifty percent. Today we're diving into behavioral finance, the
study of why we make emotional investing decisions like this
and how to master them to build lasting wealth. If
you've ever panicked during a market dip, chase a trending stock,
or second guest a solid plan, this episode is your

(00:43):
guide to staying rational and avoiding costly mistakes. Investing isn't
just about picking the right stocks or ETFs, It's about
understanding your own mind. Behavioral finance reveals how psychological biases
like fear, greed, or overconfidence lead to decision that sabotage
your financial goals. Whether you're in the US, Germany, or Canada,

(01:05):
these biases are universal, and mastering them can mean the
difference between the secure future and missed opportunities. Over the
next forty plus minutes, we'll explore how to recognize these traps,
learn from history, and adopt disciplined habits to keep your
portfolio on track. Here's what we'll cover. What behavioral finance
is and why it's critical for every investor. The most

(01:26):
common psychological biases and their impact on your wealth. Historical
and modern examples of emotional investing gone wrong. Global perspectives
on how cultural behaviors shape investment decisions, Practical strategies to
overcome biases and stay disciplined, common pitfalls, and how to
avoid them. A step by step action plan to make
rational wealth building choices. Let's dive in with a closer

(01:48):
look at why your mind is your biggest asset and
your biggest challenge. What is behavioral finance. Behavioral finance blends
psychology and economics to explain why investors often act irrationally
despite having access to data and strategies. Traditional finance assumes
people make logical choices to maximize wealth, but behavioral finance

(02:11):
shows that emotions fear of loss, greed for quick gains,
or regret. Over passed decisions and cognitive biases drive many actions.
For example, you might sell a stock like Apple during
a ten percent dip out of fear, only to watch
it sore forty percent a year later, or buy into
a hyped asset like Bitcoin at sixty thousand dollars driven

(02:32):
by FOMO just before a crash. These emotional decisions have
real costs. A twenty twenty one doll bar study found
that the average US investor underperformed the S and P
five hundred by one point seven percent annually from nineteen
ninety twenty twenty due to emotional trading, turning a one
hundred thousand dollars investment into one point two million dollars

(02:52):
instead of one point six million dollars a four hundred
thousand dollars shortfall. Globally, similar patterns emerge. VY nineteen study
by Germany's DWS showed local investors underperform their market dacks
by one point five percent due to frequent trading. By
understanding these biases, you can align your decisions with long
term goals, whether you're saving for retirement or building wealth.

(03:16):
Behavioral finance also highlights how market wide emotions amplify volatility
during bubbles or crashes. Collective fear or greed drives extreme
price swings, creating opportunities for disciplined investors, but traps for
the emotional majority. The good news, with the right tools,
you can train yourself to stay calm and rational no
matter the market's mood key psychological biases. Let's unpack the

(03:42):
most common biases that derail investors with examples to bring
them to life. Loss aversion losses hurt twice as much
as gains feel good, leading investors to sell winners too
early to lock in profits or hold losers hoping for
a rebound. Example, in March twenty twenty, loss averse investors
sold ETFs like vau during the COVID crash, missing a

(04:03):
fifty percent rebound by December. Impact Selling at lows locks
and losses while holding losers like Enron in two thousand
and one led to total wipeouts. Over Confidence investors overestimate
their market knowledge, leading to risky bets or excessive trading. Example,
in twenty twenty one, overconfident day traders piled into meme

(04:24):
stocks like GameStop at four hundred and eighty three dollars
only to lose seventy percent when it fell to forty dollars.
Impact overtrading racks up fees and taxes, reducing returns by
one to two percent annually, per a twenty twenty University
of California study. Herd mentality following the crowd, often buying
at peaks or selling at low's driven by fear of

(04:46):
missing out FOMO. Example, the nineteen ninety nine dot com
bubble saw investors chase tech stocks like pets, dot Com, Comma,
leading to a seventy eight percent NAZAC crash by two
thousand and two. Impact herd driven in buying at peaks
like Tesla at one two hundred dollars in twenty twenty one,
often precedes sharp corrections. Anchoring fixating on irrelevant data like

(05:10):
a stock's passed high, causing missed opportunities or holding declining assets. Example,
investors anchored to GE's fifty dollars peak in two thousand
held as it fell to seven dollars by twenty eighteen,
missing better opportunities like Amazon. Impact anchoring prevents selling underperforming
assets or seizing new opportunities. Recncy bias overweighting recent events

(05:32):
assuming trends will persist. Example, after bitcoin's twenty seventeen surge
to twenty thousand dollars, investors expected endless gains, but a
seventy percent crash in twenty eighteen caught many off guard. Impact.
Chasing recent winners like tech stocks in twenty twenty one
often leads to buying high and selling low. Confirmation bias

(05:52):
seeking information that supports your beliefs, ignoring contrary evidence. Example,
in twenty eighteen, crypto enthusiastic ignored warnings of a bubble,
focusing only on bullish posts, leading to heavy losses. Impact.
This bias blinds investors to risks, delaying necessary portfolio adjustments.
Historical and modern examples emotions of shape markets for centuries,

(06:17):
costing investors billions. Here are key examples. Nineteen twenty nine
stock market crash. Panic selling fueled a ninety percent market
drop by nineteen thirty two. Investors who sold at lows
lost everything, while those who held recovered by nineteen thirty seven,
per S and P data. Nineteen eighty seven, Black Monday

(06:38):
fear driven selling cause a twenty two percent single day crash.
Disciplined investors who stayed invested saw the market recover within
two years. Two thousand and eight financial crisis loss aversion
led investors to sell at the March two thousand and
nine bottom, missing a three hundred percent bull market. By
twenty nineteen, a ten thousand dollars investment in VU at

(07:00):
the low grew to forty thousand dollars. Twenty twenty one,
memestock frenzy herd mentality drove Gameshop from twenty dollars to
four hundred and eighty three dollars in weeks, but late
fomo buyers lost eighty percent when it crashed to forty
dollars twenty seventeen. Twenty eighteen, crypto boom and bust Recency
bias fueled Bitcoin's rise to twenty thousand dollars, followed by

(07:23):
a seventy percent drop. Early investors profited, but latecomers faced
steep losses. Twenty twenty two tech crash. Overconfidence in tech
giants like Meta led investors to hold as stocks fell
fifty seventy percent, while diversified portfolios lost fifteen twenty percent.
These cases show how emotions amplify market swings disciplined investors

(07:46):
who stuck to diversified long term plans consistently outperformed emotional traders.
Global perspectives on behavioral finance. Behavioral biases vary across cultures,
influenced by economic conditions and market access. US FOMO drives
retail investors to chase trends like meme stocks or crypto,

(08:06):
amplified by social media platforms like X. A twenty twenty
one Fidelity study found thirty percent of US investors traded
based on social media hype. Germany, risk aversion leads to
conservative portfolios, with forty percent of investors favoring low yield
savings accounts over stocks per a twenty twenty DWS report,

(08:27):
missing eight percent annual DAX returns. Canada, recency bias pushes
investors towards hot sectors like cannabis in twenty eighteen, which
crash sixty percent by twenty nineteen per TSX data. Emerging
markets in India, herd mentality drives gold investments during crises,
but over allocation twenty thirty percent of portfolios limits diversification

(08:48):
per a twenty twenty two RBI study. Understanding local behaviors
helps tailor strategies. For example, German investors can counter risk
aversion with low cost ETFs like MSCI World. While US
investors can avoid FOMO by limiting social media exposure strategies
to overcome biases. Here are practical, actionable ways to stay

(09:12):
rational and build wealth. Create a written investment plan. Define
your goals for example, retirement in twenty years. Risk tolerance
for example twenty percent max lows and strategy for example
seventy percent VO, thirty percent BND. Review it quarterly to
stay grounded. Example, a written rule to hold during a

(09:32):
twenty percent dip prevented selling IVO in March twenty twenty,
capturing a fifty percent rebound. Automate investments. Set up automatic
contributions to ETFs or retirement accounts, for example, five hundred
dollars monthly to a four oh one K. To avoid
emotional market timing. Example, auto investing five hundred dollars monthly
in VOO at seven percent builds one million dollars in

(09:55):
forty years, regardless of market swings. Adopt a long term
perspective focus on five ten year goals, not daily price changes.
Stocks return eighty ten percent annually over decades, per Vanguard's
nineteen twenty eight twenty twenty three data example, holding through
the two thousand eight crash yielded fifteen percent annual returns

(10:15):
by twenty eighteen, doubling a fifty thousand dollars portfolio. Diversify
to reduce stress. Spread investments across stocks, bonds, and alternatives,
for example sixty percent VOO, thirty percent BND, ten percent
VNQ to cushion losses and reduce panic. Example, a sixty
fortieth stock bond portfolio lost fifteen percent in two thousand eight,

(10:38):
while all stock portfolios lost thirty seven percent. Seek objective advice.
Use a financial advisor robo advisor for example Betterment zero
point two five percent fee, or investment group to challenge
biases like overconfidence. Example advisors in twenty twenty kept clients
invested during the COVID crash, preserving a fifty percent recovery.

(11:01):
Use mental accounting. Treat investments as long term buckets, for example,
retirement emergency fund. To avoid impulsive moves. Example, Labeling a
ten thousand dollars etf as retirement only prevents selling during
short term dips. Practice delayed decisions. Wait twenty four forty
eight hours before acting on a trade to let emotions settle. Example,

(11:23):
waiting before selling in March twenty twenty saved investors from
missing the rebound. Common pitfalls to avoid. Emotional investing leads
to these costly mistakes. Panic selling selling during dips locks
in losses in two thousand and eight. Selling at the
bottom cost investors a three hundred percent recovery by twenty nineteen.

(11:44):
Chasing trends, Buying into hype, for example, Memestock's crypto often
means buying high late. GameStop buyers in twenty twenty one
lost eighty percent overtrading. Frequent trading adds one to two
percent in fees and taxes annually, cutting a one hundred
thousand dollars portfolio by thirty thousand dollars fifty thousand dollars
over twenty years. Ignoring diversification betting on one stock or

(12:08):
sector increases risk and runs. Two thousand and one collapse
wiped out undiversified investors. Falling for confirmation bias seeking only
bullish news, for example, cryptoforms in twenty seventeen ignores risks,
leading to losses. Neglecting a plan. Investing without a strategy
invites emotional decisions. A plan anchors you to your goals

(12:31):
step by step action plan ready to master your emotions
and invest Martyr here's a detailed roadmap. Identify your biases.
Reflect on past decisions for example, panic selling in a
dip to spot patterns like loss, aversion or FOMO. Journal
your trades to track triggers. Write a clear investment plan.

(12:51):
Outline goals for example one million dollars by sixty five.
Risk tolerance for example twenty percent draw down, and strategy
for example sixty percent VO, thirty percent, BND, ten percent VNQ,
rebalance yearly. Automate contributions. Set up two hundred dollars five
hundred dollars monthly investments to ETFs or retirement accounts to

(13:13):
remove emotional timing decisions. Diversify your portfolio. Allocate across stocks, bonds,
and alternatives to reduce volatility stress. For a fifty thousand
dollars portfolio, try thirty thousand dollars VIOO, fifteen thousand dollars, BND,
five thousand dollars VNQ, limit market noise. Check your portfolio quarterly,

(13:34):
not daily. Unfollow sensational news or X accounts that fuel FOMO.
Use support systems. Consult a financial advisor, robo advisor, or
join an investment club to stay accountable, schedule annual reviews,
practice delayed decisions, wait twenty four to forty eight hours
before trading to avoid impulsive moves driven by fear or greed.

(13:55):
For example, a thirty year old investor might write a
plan to invest three hundred dollars monthly in voo, diversify
with twenty percent BND, and review quarterly avoiding fomo driven
crypto bets. During a twenty twenty one style rally, Behavioral
Finance reveals that your biggest investing challenge is often yourself.
By understanding biases like loss, aversion, or herd mentality, creating

(14:18):
a disciplined plan, and using tools like automation and diversification,
you can avoid emotional traps and build lasting wealth. It's
not about outsmarting the market, It's about outsmarting your own emotions.
As a reminder, this podcast is for informational and educational
purposes only. It is not financial advice. Always do your
own research and consult with a licensed advisor before making

(14:41):
any investment decisions. If you found this deep dive valuable,
follow the Smarter Money Show, leave a review, and share
it with someone who wants to take control of their
financial decisions, they might avoid the next market trap. In
our next episode, we'll explore sustainable investing, how to align
your portfolio with your values while still growing your wealth.
Until then, stay smart, stay patient, and stay invested.