In 2002, Princeton University psychologist Daniel Kahneman, PhD, was awarded the Nobel Memorial Prize in Economic Sciences for his ground breaking work in applying psychological insights to economic theory, particularly in the areas of judgment and decision-making under uncertainty.
System 1 - is fast, instinctive and emotional
The automatic system of decision-making evolved because it helped people make rapid decisions in situations where survival was at stake. This gave rise to a propensity to overweight negative information that had survival value.
This automatic thinking mechanism in the brain has not been turned off. This automatic system of thinking is fast because it uses shortcuts (heuristics), which in turn give rise to biases.
System 2 - is slower, more deliberate, and logical.
It has to do with orderly computations, rules and reasoning.
This behaviour explains why so few investors manage to capture the market returns, which are there for everyone to obtain and is often referred to as ‘The Behaviour Gap’:
Fortunately, there is an answer. ‘Adviser’s Alpha’.
Well, it’s explained in some detail by Vanguard but can be boiled down to a simple number – about 3% per annum. That’s the value Vanguard have calculated that a wealth management firm operating under best practices can add, and they have broken that figure down as follows:
Vanguard Adviser’s Alpha strategy
Typical value added for clients
Suitable asset allocation using broadly diversified funds/ETFs
0%
Cost-effective implementation (total expenses)
0.40%
Rebalancing
0.35%
Behavioural coaching
1.5%
Asset location
0 – 0.75%
Spending strategy (withdrawal order)
0 – 1.1%
Total potential value added
About 3% in net returns
This information is provided for illustration purposes only
At GGFS, we will help you avoid emotionally driven decisions in important money matters! Many investors are inclined to wait until things settle down during periods of volatile share markets. Some investors try to predict when the bottom of the market has been reached in an attempt to invest at the optimal time. Other investors wait until confidence has returned to the market before investing. Interestingly and ironically, even when markets do recover, and confidence does return, these very investors wait for the market to fall again before committing to an investment, in the hope of picking up some bargains. What we have learned is that it is not possible to time markets and the importance is “time invested in the markets”.
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