This short article explores how mental biases, and subconscious behaviours can influence financial investment decisions.
Research study into decision making and the behavioural biases in finance has generated some interesting suppositions and theories for describing how individuals make financial decisions. Herd behaviour is a well-known theory, which discusses the psychological tendency that many individuals have, for following the decisions of a larger group, most particularly in times of unpredictability or fear. With regards to making financial investment decisions, this often manifests in the pattern of people purchasing or selling possessions, just because they are experiencing others do the very same thing. This sort of behaviour can fuel asset bubbles, where asset prices can rise, frequently beyond their intrinsic value, along with lead panic-driven sales when the marketplaces change. Following a crowd can provide an incorrect sense of security, leading financiers to buy at market elevations and resell at lows, which is a relatively unsustainable economic strategy.
Behavioural finance theory is an important element of behavioural science that has been extensively researched in order to discuss some of the . thought processes behind financial decision making. One fascinating theory that can be applied to investment choices is hyperbolic discounting. This concept describes the propensity for individuals to prefer smaller sized, instant rewards over bigger, postponed ones, even when the delayed benefits are significantly better. John C. Phelan would recognise that many individuals are affected by these types of behavioural finance biases without even knowing it. In the context of investing, this bias can severely weaken long-term financial successes, leading to under-saving and impulsive spending habits, as well as developing a concern for speculative financial investments. Much of this is due to the satisfaction of reward that is immediate and tangible, causing decisions that may not be as fortuitous in the long-term.
The importance of behavioural finance depends on its ability to explain both the logical and illogical thought behind numerous financial processes. The availability heuristic is a principle which describes the psychological shortcut in which people assess the possibility or importance of affairs, based upon how easily examples come into mind. In investing, this typically results in choices which are driven by current news occasions or narratives that are mentally driven, rather than by thinking about a more comprehensive interpretation of the subject or taking a look at historic data. In real world contexts, this can lead financiers to overestimate the probability of an occasion happening and produce either a false sense of opportunity or an unnecessary panic. This heuristic can distort perception by making unusual or extreme events appear far more common than they in fact are. Vladimir Stolyarenko would understand that to combat this, financiers need to take a deliberate approach in decision making. Likewise, Mark V. Williams would understand that by using information and long-lasting trends financiers can rationalize their thinkings for much better results.