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Is behavioral finance worth teaching for the future?

While we agree that lack of financial literacy in Lesotho is the main culprit for poor savings and investors falling prey to scammers as it emerged during the Money Month campaigns, our recent history tells us that Basotho prefer quick money-making pyramid schemes.

Pyramid schemes deceive investors. People give a company money hoping to get more back. The money that is received from new customers is not invested to their advantage, but is used instead to pay debts owed to existing customers.  

During the peak years of the global financial crisis in 2008 and 2009, Lesotho was battling its own financial system polluted with pyramid schemes that saw lawyers, medical practitioners, university lecturers, members of parliament, members of the paramilitary forces, accountants, civil servants, employees of non-governmental organisations, rush to put their hard earned money into these quick money-making schemes.

They became instantly rich. They built second homes. They bought luxury cars. They took holiday trips abroad. They send their kids to schools overseas. The country was booming with possibilities and people were building their business empires and getting wealthy with the proceeds from this lucrative business.

But this tap would soon be closed. The pyramid schemes could no longer pay the investors and rumours started doing the rounds in the market. The bubble burst and the Central Bank of Lesotho intervened. Probably the commercial banks and insurance companies knew the game was up and they were the happiest as they competed with these pyramid schemes for deposits and premiums.

One could ask how much of financial education did our workforce – some of whom are experts in their fields – needed to prevent them from suffering huge losses inflicted by this financial bubble. Already, the government had spent millions of maloti in scholarships to educate them in universities and colleges but greed had gained an upper hand.

Many of them have yet to repay the revolving education fund but somehow they expected the same government to bail their scheming behaviour with taxpayers’ money.

How irrational?

Although forex trading looks so distant now, it also recently made newspaper headlines staging impressive returns. Local radio programmes were being interrupted by forex money, attracting strong interest from Basotho investors who later queued to forex offices at the taxi ranks to invest. The fly-by-night forex traders were funding themselves aggressively with investors’ money but never really taking positions on trading platforms because they were incompetent. Good forex traders do not spend time canvassing for deposits, instead they spend their time working on fundamental and technical strategies to take advantage of the market.

Both pyramid schemes and forex have led to a torturous time in our financial markets with no end in sight in court cases worth millions of maloti.

What is a better way to efficiently run our financial markets? Financial regulation or education or both?

Most investors in the pyramid schemes and prohibited forex schemes certainly had a profound understanding of business principles but the anomalies were evidence of investor irrationality. An understanding of investor psychology would only lead them to better investing decisions.

Behavioural finance would help them understand why they should not invest in pyramid schemes and back alley forex trading.  It would teach them to avoid the mistakes that investors make such as forecasting errors, overconfidence, regret avoidance, and framing and mental accounting.

The forecasting errors that people make are based on people giving too much weight to recent views compared to past beliefs when making forecasts. The forecasts that they make tend to be too extreme.

Overconfidence is another investment trait where investors believe they have specific situations under control and will place excessive confidence in their own abilities. This may result in fresh information no longer being carefully processed or being ignored altogether.   

Regret avoidance is a psychology trait where investors are reluctant to sell a losing investment. An investor may have bought a share and it has fallen in value. Rather than accept it was a mistake and sell quickly and take the loss, there is a tendency to hold on to the falling share.

Framing and mental accounting will affect investment decisions too. The choice of investment may be influenced by the way the investment is framed. An investor may reject an investment when it is framed in terms of losses rather in terms of gains.

I feel that the central bank has a leading role to play in terms of regulation. The commercial banks and insurance companies need to do their bit in educating their investors on the products they sell. The ministry of education should make behavioural finance part of the school curriculum from high school through to university level.

Maluti Mountain Cement

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