The Race for Behavioural Finance Analytics in Wealth Management

The investor’s chief problem – and even his worst enemy – is likely to be himself” So wrote 20th-century American economist Benjamin Graham, in what has become a source of inspiration for many investors including Warren Buffett, and a statement that resonates strongly in the current environment.

In the words of Béatrice Belorgey, CEO of BNP Paribas Banque Privée and Chair of B*capital: “In an environment marked by persistently low interest rates, the search for yield translates into greater investment in equities. Investors want higher yields, but they don’t want to take on more risks to achieve them.”

At the same time, more frequent periods of instability and high volatility in equity markets create a strong aversion to risk. In such a situation, decision-making is likely to be more emotional than rational. Investors can become more reactive to short-term events and lose sight of their long-term goals. They are guided more by market events than by their priorities.

“That’s why it’s so important to provide each of our clients with comprehensive guidance. This obviously includes financial expertise, but also an awareness of behavioural finance,” Belorgey explained.

Classical financial theory assumes that investors are rational. But a rational investor – one who makes decisions without any emotional interference – exists only in theory. In reality, every individual’s decisions and risk-taking behaviours are influenced by their own psychology, emotions and personal experience.

Human psychology has a major impact on investor behaviour. According to Dalbar, recent studies have suggested that it has a negative impact of around three percent on portfolio performance. That’s enough to double your initial investment over 20 years.

Investors experience highly variable emotional states. They can go from optimism or enthusiasm to despondency or panic. And rapid phases of market acceleration or deceleration only accentuate investors’ emotions and psychological states. Therefore, knowledge of an investor’s psychology can help everyone be more clear-headed and seek investment objectives with greater calm.

This is what is called ‘behavioural finance’, or the application of psychology to finance. The field took off with the development of prospect theory in 1979, by American psychologist and economist Daniel Kahneman, winner of the 2002 Nobel Prize in Economics, in collaboration with psychologist Amos Tversky.