Behavioral portfolio theory (BPT) is an investment theory that seeks to explain how and why investors make the decisions they do when constructing a portfolio. The theory posits that there are certain behavioral biases that lead investors to make suboptimal decisions, which in turn leads to lower returns.
The key idea behind BPT is that by understanding these behavioral biases, investors can avoid them and thus improve their investment performance.
There are a number of different behavioral biases that have been identified by BPT, but some of the most important ones include:
– Overconfidence: This bias leads investors to believe that they know more than they actually do, which leads them to take on too much risk.
– Anchoring: This bias leads investors to place too much importance on the first piece of information they receive, and as a result, they may make suboptimal decisions.
– Herding: This bias leads investors to follow the crowd, even when it may not be in their best interests.
By understanding these biases and avoiding them, investors can improve their investment performance. While BPT is not a guaranteed way to achieve higher returns, it can certainly help investors make better choices when constructing their portfolios.
