Every four years the World Cup captivates the attention of soccer fans across the globe. While the entire U.S. national team deserves praise for a valiant World Cup effort, many feel that the U.S. goalkeeper, Tim Howard, should be individually recognized for his brilliant performance against Belgium in the U.S. team’s last match. Goalkeepers play a pivotal role in soccer; and interestingly enough, a study of the strategies that goalkeepers use against penalty kicks has real implications for financial planning.
Financial planning involves analyzing your current situation and constructing an action plan to achieve your goals in the most efficient way. According to traditional economics, markets are efficient and investors behave rationally, pursuing their optimal course of action when making financial decisions. The reality, however, is that people often make irrational financial decisions that traditional economics can’t explain.
Behavioral finance is a relatively new area of academia that seeks to explain the irrational forces that drive investor behavior by blending psychology and economics. Human nature often runs contrary to successful financial planning, and in order to better manage your personal finances it’s important to understand the psychological forces that cause irrational behavior.
Soccer Penalty Kicks
Soccer is the most popular sport in the world, with top players earning millions of dollars per year. Given the enormous financial rewards at stake, traditional economics would predict that the best soccer players would be those making the best decisions.
However, a study conducted in 2005 by Michael Bar-Eli, Action Bias Among Elite Soccer Goalkeepers: The Case of Penalty Kicks, suggests that even elite soccer goalkeepers behave irrationally. When penalty kicks are involved in a soccer match, the goalkeeper must commit to a course of action before the direction of the ball is known, as there isn’t enough time to react after the kick. He has three options: jump right, jump left, or stay in the center.
Based on Bar-Eli’s data on the direction of penalty kicks, and the success of the goalkeeper in stopping them, the optimal rational decision would be for the goalkeeper to stay in the center. However, the goalkeepers chose this course of action only 6.3 percent of the time, far preferring to jump either left or right.
What’s behind this dramatic deviation from optimal behavior?
The answer lies in Norm Theory, a concept pioneered by Daniel Kahneman and Dale Miller in 1986, which holds that deviating from the “norm” magnifies the emotional impact of negative outcomes. As the data indicate, the goalkeeper’s norm is to jump right or left. When 32 professional goalkeepers were surveyed about the regret they experienced when failing to block a kick, the vast majority of goalkeepers who felt a range of regret indicated that they felt worse staying in the center than moving right or left. In other words, emotions rather than rational thinking, had greater influence on their actions.
Implications for Financial Planning
If professional goalkeepers succumb to action bias and regret aversion, should it come as any surprise that many smart investors fall victim to the same behavior? Too many investors find themselves compelled by action bias to “do something” and impulsively sell stock during market corrections. “Taking action” by selling into a down market may offer instant psychological relief, but usually at the expense of long term returns.
You can train yourself to avoid selling when everyone else is by staying focused on the odds. Countless studies, the most notable by DALBAR and Morningstar, have shown that market timing impairs returns. Take a look back at funds and stocks that you sold during past corrections. Where did prices head after you sold? Selling stocks isn’t always bad, but selling for the wrong reasons during broad-based market declines can be counterproductive. Also consider valuation before you sell during a “down” market. A stock market correction typically means that valuations have improved, along with prospects for future returns. Always remind yourself to focus on the future and not the past.
Without controlling biases that are embedded in the human psyche, you can be your own worst enemy when it comes to investing. If you need help avoiding behavioral biases that result in irrational decisions that harm returns, consider working with a CFP® professional.