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Advisor: Heal Thyself

USC professor Cary Frydman has been doing some interesting research into “neuro-finance” or how the workings of the brain impact investing.  His latest research suggests that the two biggest mental blocks to successful investing are the Disposition Effect and the Repurchase Effect.

The Disposition Effect is that investors are so afraid of losing their book-profit that they sell too soon, thinking it is important to lock-in a little profit now than taking a chance of a bigger profit later.  They often cite the old trader’s adage that “nobody ever went broke taking profits.”  They cannot “buy-and-hold” for the long term, because they are fearful in the short term.

The Repurchase Effect is a hesitation to buy back a stock that has hit bottom and started to rise again in price.  To them, this may seem like a repudiation of their earlier decision to sell, but it compounds the mistake of having sold out earlier.  Of course, a slow decision is often lost profit.

In other words, investors are too quick to get out and too slow to get back in, especially if a sold-investment has started to rise..  They tend to cite the old adage “once burnt, twice shy.”  My thought on this is that the financial advisors are particularly prone to the Repurchase Effect — in fact, even more prone than investors.  That was especially prevalent after the global financial crisis in 2009.

If advisors do a good job of holding their clients’ hands during a crash, which protects their clients from the Disposition Effect, they also preclude the Repurchase Effect, which protects both the client and the advisor.

If advisors do a good job of holding their clients’ hands during a market boom, which protects their clients from the Disposition Effect and minimizes taxes, they again preclude the Repurchase Effect, protecting both the client and the advisor.