By Richard L. Kesner, President
The CommonWealth Group
August 2005
As Investment Advisors it is important for us to understand what specific events can trigger investor reactions both in a positive and negative way. Over the last few decades Behavior Science has become a new and separate field of study, and it has provided insight as to how we all make financial decisions.
No one knows what the future holds, but it seems reasonable to assume that the massive flow of information, both positive and negative is not going to subside. The ability to process this information, exclude the noise and talking heads, and make reasonable rational decisions is what we all must learn to do.
Below we are going to provide some examples of the different decision making processes and some examples of how they have worked.
Mental Accounting
Mental Accounting occurs when a person treats a sum of money differently from another equal sum due to where it is kept, from where it is obtained or for what it is to be used. When the Boston Celtics were a championship quality team, with Larry Bird and Kevin McHale staring to MIT researchers conduct an experiment in which subjects participated in a closed bid process for Celtics playoff tickets, which were in high demand. One group was told they must pay with cash. The other group could charge the tickets if their bid was accepted. The average bid for those with charging capability was almost twice as much as the average bid for the all cash group. Another example of Mental Accounting occurs with people who treat a bonus different than lottery winnings.
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