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The FinTech Chemist: What’s Blooming in Behavioral Finance?

Studying the properties and composition that make up the FinTech ecosystem

Welcome to this week’s industry analysis with the FinTech Chemist. A wise man once said, “What makes us strong as human beings makes us weak money managers.” That wise man happens to be Dr. Daniel Crosby, a behavioral finance expert. After years of research, teaming up with Brinker Capital, and financial advisors clamoring for a behavioral finance technology platform, he’s delivering Tulip. So, let’s find out what’s blooming in behavioral finance.

FinTech Chemist: Daniel, it’s always a pleasure speaking with you. I find this area of the industry fascinating. In layman’s terms, what is behavioral finance and ultimately, what's the case for saying that humans ultimately make weak money managers?

Dr. Crosby: So behavioral finance, my favorite sort of colloquial definition of behavioral finance, is finance that accounts for the messiness of human behavior. So many standard econometric and financial assumptions are modeled on humans that maximize utility – humans that always make the right choice. That's just simply not the case. And so behavioral finance is just sort of finance that accounts for the messiness of human behavior in terms of what's the evidence that people don't make great money managers. The most popular and probably the most controversial study out there is the Dalbar study. It's controversial because it shows the largest effect size. It effectively says that people leave half of the available returns on the table. Other estimates are smaller, but it's generally somewhere between 2 and 4%. I mean, every study that's ever looked at it shows that there's a delta between what the market gives us and what people actually take home. And the biggest contributor to that is human psychology.

FinTech Chemist: And what are some of the biases studied in behavioral finance? What are some that stand out to you ...

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