Behavioral Economics:

Modern Portfolio Theory contends that investors are rational, dispassionate, and understand the odds.

Fortunately for active portfolio managers, fifty years of financial evidence and behavioral research contradicts this theory.

Behavioral Economics is a relatively new discipline that attempts to define the way investors actually make choices. Researchers have repeatedly found that investors regularly violate the basic rules of rational decision making - to their detriment.

Click the video below to see Daniel Kahneman, one of the father's of behavioural economics, discuss how cognitive biases negatively impact investment decisions:

There are many more behavioral biases that cause investors to make poor choices. However, many investors, especially well educated ones, suffer from illusory superiority, which convinces them that the behavioural vulnerabilities above do not apply to them. Understand that these biases apply to me, you, and everyone else - unless you take active steps to avoid them!

A recent study by global investor research group Dalbar showed that most investors (blue bar) dramatically lagged stock and bond indices (green bar) since 1985 because of poor buy and sell judgment. Behavioral biases caused investors to follow vocal market 'experts' (click here and here) and strategic fund company marketing into hot sectors at the wrong time.

Click chart above for a larger version.
Source: Dalbar (2009), Butler|Philbrick & Associates

Large financial organizations have much to gain from keeping investors in stocks through thick and thin. For most organizations, it would be impossible to move all clients quickly into safe investments, so they advocate 'Buy and Hold' by default. This works well during long bull markets like we experienced from 1982 through 2000, but this is unlikely to persist over the coming decade (click here, here, and here for our reasoning).

Investors need a smarter way to avoid future bear markets without relying on expert forecasts or 'intuition'. Smart investors recognize the destructive power of their behavioral vulnerabilities, and stick to a buy or sell formula created IN ADVANCE. Our Gestalt Architecture incorporates a proven buy and sell discipline that has demonstrated tremendous value over time.