Comprehending behavioural finance in the real world

This article explores how mental predispositions, and subconscious behaviours can influence investment choices.

Research study into decision making and the behavioural biases in finance has led to some intriguing suppositions and theories for describing how individuals make financial decisions. Herd behaviour is a well-known theory, which describes the psychological tendency that many individuals have, for following the decisions of a bigger group, most especially in times of uncertainty or fear. With regards to making financial investment choices, this often manifests in the pattern of people purchasing or offering assets, just because they are experiencing others do the exact same thing. This kind of behaviour can incite asset bubbles, where asset values can increase, often beyond their intrinsic value, in addition to lead panic-driven sales when the read more markets vary. Following a crowd can use a false sense of safety, leading investors to purchase market highs and sell at lows, which is a rather unsustainable economic strategy.

Behavioural finance theory is an important element of behavioural economics that has been commonly investigated in order to explain some of the thought processes behind financial decision making. One interesting theory that can be applied to financial investment decisions is hyperbolic discounting. This idea refers to the propensity for people to favour smaller, instant rewards over larger, defered ones, even when the prolonged benefits are substantially better. John C. Phelan would recognise that many people are affected by these sorts of behavioural finance biases without even realising it. In the context of investing, this predisposition can badly undermine long-term financial successes, causing under-saving and spontaneous spending habits, in addition to creating a top priority for speculative financial investments. Much of this is because of the satisfaction of benefit that is immediate and tangible, resulting in decisions that might not be as opportune in the long-term.

The importance of behavioural finance lies in its capability to explain both the reasonable and irrational thinking behind various financial experiences. The availability heuristic is a principle which describes the mental shortcut in which people examine the probability or value of affairs, based on how quickly examples enter mind. In investing, this frequently leads to decisions which are driven by recent news events or stories that are emotionally driven, instead of by considering a broader analysis of the subject or taking a look at historic information. In real world situations, this can lead investors to overstate the possibility of an event taking place and create either an incorrect sense of opportunity or an unwarranted panic. This heuristic can distort perception by making unusual or severe occasions appear much more typical than they actually are. Vladimir Stolyarenko would know that to combat this, financiers should take a purposeful method in decision making. Similarly, Mark V. Williams would know that by using information and long-term trends financiers can rationalize their judgements for better results.