The average investor underperforms both the markets themselves and their own investments.  Today, Lou Melone of Melone Private Wealth joins RJ King of D Business magazine to break down why.  Much of it comes down to behavior.  Investor's thoughts trigger their emotions, emotions define behavior, and behavior determines performance.

Through 26 years of financial planning, incorporating data from Dalbar, Lou has developed a model for the anatomy of investor returns, made up of five parts.

1. The Stimulus
2. The Behavior
3. The Volatility
4. The Retention Rate
5. The Asset Class

Human nature often responds to a stimulus.  And the fear response of the amygdala in our brain will bypass our higher brain functions.  This is what saved cavemen from being eaten by sabre toothed tigers.  Unfortunately, today, that fear comes from strategists, friends, family, and the financial media.   And it takes planning, practice, and education to override this natural, fearful response.

Lou and RJ break down 5 behaviors, or cognitive biases, that plague investors.  They are Loss Aversion, Mental Accounting, Anchoring, Herding, and Availability Bias.

Volatility is an often-misunderstood part of the markets and investing.  Often, investors confuse market volatility with risk.  Lou explains the difference, and why volatility can be a good thing.

Retention Rate is often affected by market conditions - and investors often abandon their strategies in both good and bad times. And while there's always someone claiming they can time the market, it's never worked consistently in the long term.

Finally, RJ and Lou break down returns by asset class, including stocks, bonds, T-bills, gold, and the US Dollar. Higher volatility tends to lead to larger long-term returns.

Behavioral investing boils down to psychology, and this is why it's so important to work with a Financial Planner.  In our next episode, we will explore what to look for when hiring one.

Resources:

Lou Melone's book, "Unpack Your Financial Baggage:" https://www.amazon.com/Unpack-Your-Financial-Baggage-Misconceptions/dp/1948237776

Melone Private Wealth Website: https://www.meloneprivatewealth.com/

D Business Magazine Website: https://www.dbusiness.com/