Behavioral Finance and the Christian Investor

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This article was originally presented at The Christian Economic Forum 2018.
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The Christian Economic Forum hosts a world-class Global Event each year to connect the top industry leaders and experts from around the world with other individuals who are compelled to act upon the principles of God’s economy. The following paper was presented at CEF 2018.

by Vince Birley

Much attention is being given today to the behavioral study of investors. Irrational investment decisions have resulted in below market returns for many investors. This is coupled with neurological research revealing strong psychological impact from investment gains and losses. This paper will inform readers of these studies and asks the question, Should Christians be susceptible to the same challenges or should they be advantaged?

With the advent of technology and data, along with the democratization of people owning stocks and bonds through mutual funds, studies have been conducted to determine how average investors perform. One of the more popular studies has been done by a financial services research firm called Dalbar. Their 30-year study concluded that the average investor fails even closely to achieve market-index returns. Over the last 30-year period (ending December 2016) the S&P 500 returned an average of 10.16% per year, while the typical investor in stock mutual funds achieved only 3.98%. Dalbar’s study also found that during the same period, the average bond investor earned on a 0.57% return per year while the Barclay’s Aggregate Bond Index earned 6.34% per year. That is a startling 6-7% difference per year over 30 years that investors have missed.

This gap is explained by irrational investor behavior. We’ve all seen it...investors buy their funds when the funds had good performance (buy high) and sell their funds when they had bad performance (sell low). There was no rational explanation of this decision making, so psychologists saw this as a ripe study in the field of human behavior.

The psychological field’s explanations included theories of regret, mental accounting, prospect/loss aversion, anchoring, over/under reacting, and overconfidence. Without going into great detail, all of these explanations can be summed up by two quotes from Jason Zweig’s book, Your Money and Your Brain. In his book Zweig mentions the brain’s reactions to paper gains and losses: “Financial losses are processed in the same areas of the brain that respond to mortal danger.” Zweig adds that, “the neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine.” In summary, investors are emotionally fearful and stimulated by their investment gains/losses, which drives them to make irrational decisions of selling low to avoid loss and buying high to participate in what others are gaining.

So how should Christians fare with these challenges? In theory, our faith in God should minimize our love for money, giving us an advantage of less emotional attachment to gains and losses. But as I witnessed during the 2008-09 financial crisis, many Christians’ fears were equal to or greater than those who did not have faith in Christ.

Applying a biblical worldview to these challenges should help Christians. This starts with our motivations to save and invest in the first place. Christians should ask themselves two key questions: “Why should I invest my savings?” and “What should be my motivation?”

The motivation behind investing can be traced to the Fall. Living in the Garden of Eden was abundant and without risk or scarcity. The Fall changed our environment where risks of poor health, destructive weather, repressive leadership, and theft could all create periods of scarcity. The Bible’s answer to this scarcity was for humans to use their talents to be productive and to moderate current consumption, thereby creating savings for future proverbial rainy days. Therefore, our motivation for saving and investing should come from our recognition that we live in an environment where the future is uncertain and unstable, thus saving is prudent.

Considering this motivation, Christians should have clear investment return goals. While the investment industry is focused on relative returns (how are your investment returns compared to other’s returns), the focus for those who are saving should be to pursue absolute returns (your actual return off the principal invested). Focusing on relative returns can lead to covetousness and discontentment, which distracts from living and serving others. It can also lead to poor investment decision making, joining into market bubbles, or taking excessive risk to “catch up.”

In pursuing absolute return goals, an investor needs to understand the risks associated with accomplishing these goals. These risks will help determine a realistic return expectation for investors. Houses built on solid rock can endure storms while those built on sand cannot. Examples of building solid investment foundations are investments in countries and companies where: 1) leadership and governance are accountable, 2) workers are respected, incented, and protected, 3) proper levels of diversification exist in countries, industries, and companies, and 4) there is a disciplined valuation methodology to buy into investments with reasonable valuation levels. Risk in a post-Fall world cannot be eliminated; even so, investors can increase their probabilities of investment success by using wisdom in their investment decision making.

Christians should also be motivated to live a life of faith and not a life of fear and anxiety. We are told not to put our hope or trust in our earthly possessions and to live life with a view to our eternal home. This means answering the question, “How much is enough?” We are warned not to accumulate so much that our faith transfers from God to our net worth while being prudent in taking care of our families. Developing a personal financial and investment plan based on wisdom and faith should result in living a life that is not worried about losing our earthly wealth, but instead is focused on generously serving others with God’s provision.

In summary, Christians should be advantaged as investors by being more emotionally stable in market crises or euphoria. We have the advantages of knowing our God as our provider and trusting in His provision with contentment. In addition, we have instructions on the nature of risk and on aligning our investment strategies based on how God designed the world to work. Christians should see financial markets as a great test to ensure that their love and security stays with God and are not misplaced with money.

Read the whitepaper in its original form here.