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JAForlines Global: Buy High and Sell Low Have Scientific Roots


New York, February 20, 2013, Advisor Update®

Behavioral Finance has become an important tool for investment managers, financial advisors and fiduciaries. Classical economics theory posits that investors act rationally, but the truth is the opposite. First, investors are far more interested in risk avoidance strategies than gains-seeking strategies. Yet they constantly overstate their comfort level with risks when risk markets are going up. This leads to herding mentality and eventually grave disappointments like 2001-2002 and 2008. Second, investors are hardwired with certain biases that make investment decisions difficult.

One bias we’ve highlighted here with some frequency is “Availability Bias,” where investors give priority to “new” information on an investment “theme” despite having a thorough grounding in asset allocation principles by their financial advisor. The media and their masters, advertisers, prey on this bias and the result is short-term pursuit of “hot” investments to the detriment of a long-term plan.

Not surprisingly, financial institutions have begun working with Behavioral Finance professionals, incorporating Behavioral Finance principles into their research. Here is an example aimed at financial advisors and their clients from Barclay’s Behavioral Finance group:

Sources: Barclays Bank, PLC and JAForlines Global

Global Tactical Asset Allocation investing requires a full Behavioral Finance toolkit too: we fight to avoid biases and pundit influence on our thinking. Financial television is full of breathless “experts” worrying about the meaning of 200 day moving averages, trend reversals and whether the Yankees have enough pitching this year. Well, the last one is worth a thought anyway.

The calculus for 2013 investing seems to be set as far as we‘re concerned. If a recession can be avoided in the US, and China hits a moderate GDP growth target of 7.5%, then this will be a solid year for a diversified portfolio which largely avoids government bonds. One of our favorite macro economists, Scott Grannis, agrees:

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