Behavioural Finance

The documented ways people mis-decide under uncertainty — stated as arithmetic rather than as scolding, because the arithmetic is what changes behaviour.

Why this is arithmetic, not psychology

• Knowing a bias exists changes almost nothing. Everyone knows selling in a panic is unwise, and the flows show it happening in every drawdown on record.
• What does shift behaviour is seeing the cost as a number, before the moment arrives. That is what this page is for: each section pairs a documented tendency with the calculation that prices it.
• The countermeasures at the end are structural — automation, written rules, pre-commitment — because willpower during a crash is not a plan.

Loss aversion: the asymmetry that drives most of it

• Losses are experienced roughly twice as intensely as equivalent gains. That single finding explains selling after falls, holding losers to avoid realising a loss, and refusing sensible risk.
• It has a real arithmetic consequence: a 50% loss needs a 100% gain to recover. The drawdown calculator makes the asymmetry concrete, and it is the honest argument for caring about drawdowns rather than only about average returns.
• The disposition effect is its clearest market form: investors sell winners too early and hold losers too long, because realising a loss makes it feel final. Documented repeatedly across markets, and tax-inefficient in most jurisdictions on top.
• Mental accounting compounds it — money is treated differently depending on which pot it sits in, so a portfolio is managed as a set of unrelated bets rather than as one position.

Market timing: the cost of being out

The strongest empirical argument against timing is not that it is hard. It is that the market's best days cluster inside its worst weeks, so avoiding the falls means missing the recoveries.

Waiting for a better entry

The most common way money sits in cash is not a decision to hold cash — it is a decision to wait. That wait has a price, and the price is knowable in advance.

The rest of the catalogue, with what each costs

Where behaviour meets structure

• The behaviour gap — the difference between a fund's return and its investors' — is the aggregate measurement of everything above. It is widest in the most volatile products, which is where the marketing is loudest. See portfolio practice.
• Products are designed around these tendencies. A high headline coupon on a reverse convertible, a "capital protected" label on a structured deposit, a payoff diagram that stops before the bad scenario — each targets a documented preference. Recognising the design is the defence.
• Leverage converts a behavioural error into a solvency event. The same mistake at 1× is a bad year; at 20× it is the end of the position, before you get the chance to be right — the pattern in LTCM and every case that follows it.

What actually works

• Automate the decision away. A standing contribution removes the moment of choice entirely, and it is the single most effective countermeasure available to a household.
• Write the policy before you need it. Target weights, rebalancing bands, and an explicit answer to "what will I do after a 30% fall" — decided in calm, executed in noise.
• Make the default inaction. Structure things so that doing nothing is what happens unless a written rule fires. Most portfolios are damaged by activity, not by neglect.
• Keep a decision journal. Write the reasoning at the time. It defeats hindsight bias, which otherwise rewrites every past decision as obvious and prevents any learning.
• Reduce the observation frequency. Checking daily makes losses appear far more often than gains at any positive drift — the mechanism behind myopic loss aversion. Looking less is not denial; it matches the observation interval to the horizon.
• Assume you are not the exception. Every study finding these effects surveyed people who were confident they were immune.