Far from Oprah-style or drive-time psychobabble, the tenets of behavioral economics are now widely accepted by advisors and clients alike. In its simplest form, the theory, first developed by Amos Tversky and Daniel Kahneman (for which the latter won a Nobel Prize), states that contrary to traditional economic theory, investors and markets are not fully rational.
Translation — we’re very adept at screwing ourselves.
A simple market illustration reinforces the point: An oft-repeated statistic from a 2003 Dalbar Survey of Investor Returns finds the average mutual fund investor earned only 2.6 percent annually from January 1984 through December 2002, compared to annualized inflation of 3 percent and an S&P 500 return of 12 percent.
In other words, during one of the greatest bull markets in American history, the average investor’s return failed to keep pace with inflation and was a fraction of what they would have received had they simply tracked the S&P 500.
The underpinnings of behavioral economics of course go far beyond financial services and market investing. It most famously made its mainstream debut in Moneyball, Michael Lewis’ bestselling book and movie of the same name starring Brad Pitt.
In that case, professional baseball players were valued according to perception, rather than performance; that is, until behavioral economics expert Peter Brand came along.
Where are we going with this? Simple — the decision about when and how to claim Social Security is no different. The strategy that’s ultimately chosen is too often influenced by external (and incorrect) stimuli rather than sound analysis and ends up hurting recipients in the long run.
Take the following refrains we continually hear:
1. “I want the money now before Social Security goes broke.”