Accretus Solutions Blog » behavioural finance http://blog.accretus.in Managing Wealth in the New Normal Wed, 05 Jan 2011 17:45:23 +0000 http://wordpress.org/?v=2.9.2 en hourly 1 The Science and the Art of Goals Based Investing http://blog.accretus.in/investment-trends/the-science-and-the-art-of-goals-based-investing/ http://blog.accretus.in/investment-trends/the-science-and-the-art-of-goals-based-investing/#comments Wed, 10 Mar 2010 20:17:39 +0000 Partha Iyengar http://localhost/accretusblog/?p=121 2008 crisis has brought ‘Behavioral Finance’ to the fore front in managing wealth in the ‘New Normal’. The traditional finance which relied on the ‘modern portfolio theory’ developed by Nobel Prize winning author, Harry Markowitz have been subjected to severe scrutiny during the long bear markets, when portfolios under performed severely compared to their benchmarks. This was due to the fact that it assumed the market movements go through normal periods of ups and downs or bell shaped curve. While developed markets like U.S. gave negative returns over a ten period, Japan has been under water for the last two decades whereas some of the emerging markets like India gave abnormal returns during the latter half of the ten years. The normal distribution curve got replaced with ‘fat tails’ or highly unusual market moves.

How does one deal with these kind of extra-ordinary period of super normal returns and abnormal returns?

One of the better methods to overcome these anxieties of extremes in portfolio performance during these turbulent times is to stick to goal based approach to investing. An interesting report to improve wealth management for individual investors was proposed by Dan Nevins, where in he takes into account the various factors that impact the investment decisions for investors. Terms like ‘loss aversion’, ‘mental accounting’, ‘over confidence’, ‘hind sight bias’, ‘over reaction’, ‘belief perseverance’, regret avoidance’ from behavioral finance builds the case for ‘Goal Based Investing’ approach. More importantly, it specifies the need to look at risk from portfolio level as well as goals level and accordingly deploy assets to for specific time frames to achieve those goals .Though the report was written in 2003, it is all the more valid and increasingly being applied in the wealth management space. The report has also laid out some strategies to manage investments over different time periods and life style goal needs.

To conclude, it is important to understand that managing wealth involves marrying the traditional finance with modern finance.

Goal based investing is the way to go.

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