September 3, 2021
Finance is a versatile sector, and it has many forms. We have behavioral finance, which may not be a very popular term for many people, but surely it is an interesting thing to understand. In a way, it is part of our daily life, but we do not even know that it exists so deeply around us.
An understanding of the concept of behavioral finance can open the doors to an enlightening subject. The financial experts are already working on it because it has the power to affect the market.
What is behavioral finance?
Behavioral finance is the study of the impact of psychology on investment decisions. It says that investors do not always follow logic because they are affected by their own biases. The study is not only of investors but also financial analysts because they need to make unbiased conclusions on market conditions.
Anyone in the effect of personal emotions cannot make rational financial decisions, which can affect the market. It is the reason that behavioral finance is important because it helps to understand the effect of human behavior and psychology on financial and investment decisions.
5 types of biases in behavioral finance
This type of finance deals with varied behavior issues that may hamper rational decisions in financial life. For example – the desperate desire to flaunt at the wedding may make someone spend extravagantly. That can make a person exploit its invested money before time.
Behavioral finance teaches about how to make logical decisions in life. For example – in place of taking a hefty wedding loan, one should consider taking a home improvement loan because that is like a future investment. After some years, he can sell the house at a higher price.
- Overconfidence – Investors are more prone to this issue, especially beginners. They invest thinking that they are sure to get the profit. They may either put money in the wrong investment option or put a lot of money without understanding the market.
- The narrative fallacy – Is about the inability when someone fails to understand the sequence of facts. In investment decisions, this inability may cause obstruction in smart decision-making. The person may lose insight into the real conditions of the market.
- Confirmation bias – Confirmation bias is when a person finds the information that supports his values and beliefs. In that case, you can understand that it is not possible to expect rational decisions. A financial analyst with this bias may bring wrong information in light.
- Framing bias – It is the bias that makes people make decisions on the basis of the presentation without considering much the facts and figures. Such decisions may not be harmful to finances if it is about a small loan borrowing like fast loans in Ireland. Nevertheless, it is not safe in investment.
- Anchoring bias – In this type of bias, a person takes all the decisions depending on a particular reference point, which acts as the prime influencer. In finances, it can cause a wrong decision, and that can affect the whole market.
How to tackle behavioral issues in finance?
After studying behavior bias issues, it also suggests ways to help prevent the problems and make rational decisions.
- Prepare, plan and stay committed
To make correct investment decisions and analyze the market without any bias, and it is necessary to work stepwise. It is important to prepare and plan for your future activities and stay committed to with while maintaining the rational attitude.
- Follow the process
To avoid any wrong decisions due to personal bias, it is vital to follow the process. When you do that, your personal emotions do not get the chance to interfere. For example – you can apply for an investment option only in case of a certain type of risk appetite.
- Think rationally
This is the basic but most important practice in the case of behavioral finance issues. However, it can be not easy, but it is really important to be able to think rationally. Only when you think of logic can you understand the reality on the other side of the coin. It is vital for a peaceful life.
The basics of behavioral finance explain that no matter how modern we become, humans are always affected by their personal biases. This cannot work in financial life because money is a rational thing, and it has nothing to do with your emotions. If the market is down, it is down, and you may get lost if you act foolishly.
If the market is high, you need to invest in the right opportunity to earn huge profits. In short, it is really important to understand that our behavior is always the dominating factor in finances. But if that makes us make inaccurate decisions, multiple issues dominate the financial life.