This short article explores how psychological predispositions, and subconscious behaviours can influence financial investment decisions.
Research into decision making and the behavioural biases in finance has generated some intriguing suppositions and theories for discussing how individuals make financial decisions. Herd behaviour is a popular theory, which discusses the mental propensity that many people have, for following the actions of a larger group, most particularly in times of uncertainty or fear. With regards to making investment choices, this frequently manifests in the pattern of people purchasing or offering possessions, just because they are seeing others do the same thing. This sort of behaviour can fuel asset bubbles, whereby asset prices can rise, frequently beyond their intrinsic value, in addition to lead panic-driven sales when the marketplaces change. Following a crowd can provide a false sense of safety, leading investors to purchase market highs and resell at website lows, which is a relatively unsustainable financial strategy.
The importance of behavioural finance lies in its ability to explain both the rational and unreasonable thought behind numerous financial processes. The availability heuristic is a concept which explains the mental shortcut through which people assess the possibility or importance of affairs, based on how easily examples come into mind. In investing, this typically leads to choices which are driven by current news occasions or narratives that are mentally driven, rather than by considering a wider interpretation of the subject or looking at historic information. In real world contexts, this can lead investors to overstate the possibility of an event happening and create either a false sense of opportunity or an unwarranted panic. This heuristic can distort understanding by making uncommon or severe events appear much more typical than they actually are. Vladimir Stolyarenko would understand that to combat this, financiers should take a deliberate approach in decision making. Likewise, Mark V. Williams would know that by utilizing data and long-term trends financiers can rationalize their thinkings for much better results.
Behavioural finance theory is an important aspect of behavioural science that has been widely investigated in order to describe some of the thought processes behind monetary decision making. One intriguing theory that can be applied to financial investment decisions is hyperbolic discounting. This concept refers to the propensity for people to prefer smaller sized, momentary benefits over larger, defered ones, even when the delayed rewards are significantly more valuable. John C. Phelan would recognise that many people are affected by these kinds of behavioural finance biases without even realising it. In the context of investing, this bias can seriously weaken long-lasting financial successes, leading to under-saving and impulsive spending practices, in addition to producing a top priority for speculative financial investments. Much of this is because of the satisfaction of benefit that is immediate and tangible, causing choices that may not be as opportune in the long-term.