Investors should learn about psychological biases

MOST standard courses on investing are aimed at improving the individual’s ability to make informed decisions in the hope this will lead to better financial health. Students are taught to know their investment horizons and risk profiles; create suitably diversified portfolios by using fundamental analysis; look at earnings; employ dollar-cost averaging; and to buy and hold for the long term rather than indulge in short-term trading.

These are tried and trusted principles of investing – at least in theory. In practice though, many people make all sorts of mistakes when it comes to their finances – they buy high and hope to sell higher, hold on to losing positions for too long before cutting losses and succumb to herd instinct, probably driven by FOMO (fear of missing out).

The root problem is that standard financial and economic theory assumes all people are governed by perfect self-interest, perfect rationality and perfect information. These assumptions are relaxed to some degree in certain models, but by and large, most standard economic frameworks rely on humans being rational and selfish, and markets being efficient.