This article explores how mental predispositions, and subconscious behaviours can affect financial investment choices.
The importance of behavioural finance depends on its ability to discuss both the rational and irrational thought behind different financial experiences. The availability heuristic is a concept which explains the mental shortcut through which individuals evaluate the probability or significance of events, based upon how quickly examples come into mind. In investing, this typically leads to decisions which are driven by recent news events or narratives that are emotionally driven, rather than by thinking about a broader evaluation of the subject or looking at historic data. In real world situations, this can lead financiers to overestimate the probability of an event occurring and produce either a false sense of opportunity or an unwarranted panic. This heuristic can distort understanding by making rare or extreme events appear far more common than they really are. Vladimir Stolyarenko would know that in order to combat this, financiers should take a deliberate approach in decision making. Similarly, Mark V. Williams would understand that by using data and long-lasting trends financiers can rationalize their judgements for better outcomes.
Behavioural finance theory is an essential element of behavioural economics that has been commonly researched in order to describe a few of the thought . processes behind economic decision making. One fascinating principle that can be applied to financial investment decisions is hyperbolic discounting. This idea refers to the propensity for individuals to favour smaller, instant benefits over larger, delayed ones, even when the delayed rewards are substantially better. John C. Phelan would acknowledge that many individuals are impacted by these types of behavioural finance biases without even realising it. In the context of investing, this bias can significantly undermine long-term financial successes, causing under-saving and impulsive spending practices, as well as developing a concern for speculative financial investments. Much of this is because of the gratification of reward that is immediate and tangible, resulting in decisions that may not be as opportune in the long-term.
Research study into decision making and the behavioural biases in finance has led to some fascinating suppositions and theories for describing how people make financial choices. Herd behaviour is a well-known theory, which describes the psychological propensity that many people have, for following the decisions of a bigger group, most particularly in times of unpredictability or worry. With regards to making financial investment choices, this often manifests in the pattern of individuals purchasing or offering properties, merely due to the fact that they are seeing others do the very same thing. This kind of behaviour can fuel asset bubbles, whereby asset prices can rise, typically beyond their intrinsic value, as well as lead panic-driven sales when the marketplaces fluctuate. Following a crowd can use an incorrect sense of security, leading investors to purchase market elevations and sell at lows, which is a rather unsustainable economic strategy.