Charles Rotblut, a vice president at the American Association of Individual Investors, offers investment strategy tips to address the irrationality and emotionality that drive many investment decisions. Rotblut points to evidence of a “behavioral gap” suggesting that over a nearly 20-year period, the average mutual fund investor has realized only 50% of S&P 500 gains. Many people buy high and sell low due to effects discussed in behavioral economics literature. Rotblut draws heavily on psychology of decision-making and risk that underlies behavioral economics, such as prospect theory (“the psychological effect of losses is far greater than [that] of gains”) and various heuristics that undermine our ability to act as the “rational agent” described in many economic theories.
He offers five strategic tips for investors to address the problems driving irrational decision-making:
- Write down the rules governing how you manage your portfolio.
- Include guidelines for long-term portfolio management with these rules.
- Develop techniques to cope with the inevitable emotions and nervousness that come with investing.
- Create “sell rules” in advance and stick to them.
- Take the time to “slow down” and think through a situation before taking investment actions.