Behavioral Finance: Biases, Emotions and Financial Behavior
Human behavior is complex. There are many factors that play into our decision-making process. These include emotions, personality traits, past experiences, cultural norms, and more. Because of this complexity, it can be hard for us to understand why people do the things they do. As a result, we often attribute certain behaviors to external forces, such as luck or chance.
Over the next few months we will explore human behavior and how it impacts you as an investor. This field of study as it relates to investing is often referred to as behavioral finance. Our hope is that you can become a more cognitive investor and be able to detect and manage the emotions that come with investing.
What Is Behavioral Finance?
Behavioral Economics is a new field of study based on the idea that economic activity is driven by human psychology. Therefore, if you want to really understand how people behave when it comes to their finances, you need to look at their psychological makeup. If you study this topic, you’ll find out that there is a lot of common ground between behavioral finance and traditional economics.
For example, both approaches share similar ideas about rationality. However, while economists tend to focus on the rational side of behavior (i.e., what people actually think), behavioral finance looks at emotion and motivation instead. This helps explain some seemingly irrational decisions, including risk-taking and overconfidence.
There are also similarities in terms of methodology.
Understanding Behavioral Finance
Biases are a form of cognitive bias, and emotions are states of feeling that come from within. These are both unconscious processes. They are present in all humans and have been observed since our distant ancestors were living together as small groups. Bias is generally seen as being either positive (in favor) or negative (against). In other words, it can be said to be an opinion; someone’s perspective of the world around him or her. An emotion is something we feel, like happiness, sadness, fear, anger, etc. People tend to use these biases in decision making when they are choosing between two things.
Emotions play a big part in how people behave. We may experience some emotional responses to situations and events but not others, depending on whether we view them positively or negatively. A person who is happy has different reactions than a person who is sad, for example.
Behavioral Finance Concepts
Behavioral finance is an approach used in economics to study financial markets. Like behavioral psychology, it focuses primarily on human behavior. Behavioral finance studies issues like risk aversion, loss aversion, cognitive biases, and emotions (just to name a few).
Some researchers believe that the traditional economic theories are not enough. They argue that we need to look at people’s real-life decisions and behaviors. These theorists claim that much of the time, economists only focus on rational decision making.
However, there are many things that go into a person’s decision-making process. For example, if a student is interested in a college, she might do some research to see what types of jobs graduates have after they graduate from school. She might then use her research to make a better informed choice about which college to attend. The student doesn’t necessarily care about the quality of the campus or how nice it is – just whether or not there are a lot of good job opportunities.
Behavioral finance is a field of economics that looks at human behavior from an investment perspective. One major concept is behavioral psychology, which is defined as the study of psychological factors that influence economic decisions. There is some overlap with financial engineering, which is the application of technology, data science and analytics to solve problems in the world of investing.
How Does Knowing About Behavioral Finance Help?
Behavioral finance is a subfield of economics that studies financial decision making. The primary purpose of behavioral finance is not to predict future stock prices. Rather, it is to understand the factors that cause investors to make irrational choices or avoid making rational ones. In short, it attempts to explain why we behave so irrationally in the markets.
The main focus of behavioral finance is to explain why human behavior deviates from rational economic behavior. There are three basic tenets of behavioral finance. First, humans do not always act rationally, so it makes sense to study non-rational human behavior. Second, human emotions play an important role in investment decisions. Third, the environment influences human decision making.
Behavior is any human activity that requires thought, judgment, planning, decision-making, or action. Investing is a process of managing assets for financial gain. In both cases, we need to understand why certain behaviors occur, so as to improve our ability to predict future actions.
As humans, we have evolved to be able to make sense of the world around us. Our senses are designed to detect things like food, water, danger, and sex. However, when it comes to predicting human behavior, there are some common features that all individuals share. For example, people who are hungry tend to eat; people who are thirsty tend to drink.
Conclusion
In conclusion, we often take our investments, savings, and even our daily decisions on the basis of what’s rational. We have an innate desire to maximize short-term gains and minimize long-term losses. This behavior is called “rational” because it seems like it would lead us to success. But while most investors think they are rational decision making creatures, the reality is that they fall prey to behaviors and biases that result in missed opportunities and poor investment performance.
Investors would do well to work with a trusted financial planner or advisor to understand better regarding why they do the things they do when it comes to investing and planning their future. The goal of every investor is to raise their cognitive awareness and learn to make rational decisions when it comes to their finances.
Over the next few months we will be exploring in more detail behavioral finance and what you can do to recognize the potential gaps and how to respond in any type of market or situation.
