Explained: What is behavioural finance and its implications
Behavioural finance research has important implications for investors that can influence their decision-making. In this article, we will explore further about it.
Behavioural finance is a field of study that examines how psychology and human behaviour affect financial decision-making. It is a relatively new field, having emerged in the 1970s and 1980s. Behavioural finance has had a significant impact on our understanding of how financial markets work and how investors make decisions.
Behavioural finance research has shown that investors are not always rational. They can be influenced by a variety of biases, including:
Anchoring bias: The tendency to rely too heavily on the first piece of information they receive when making a decision.
Availability bias: The tendency to give more weight to information that is readily available.
Confirmation bias: The tendency to seek out information that confirms their existing beliefs and ignore information that contradicts them.
Fear of missing out (FOMO): The tendency to make decisions based on the fear of missing out on an opportunity.
Herd mentality: The tendency to follow the crowd and make decisions based on what others are doing.
These biases can lead investors to make poor financial decisions. For example, an investor who is anchoring bias may be more likely to hold on to a losing stock because they bought it at a higher price. An investor who is susceptible to confirmation bias may be more likely to invest in a company that has been in the news recently, even if the company's fundamentals are not strong.
Behavioural finance research has also shown that investors are influenced by emotions such as greed, fear, and regret. These emotions can lead investors to make impulsive decisions that they later regret. For example, an investor who is experiencing greed may be more likely to chase a hot stock, even if it is overvalued. An investor who is experiencing fear may be more likely to sell a stock at a loss, even if it is a good investment in the long term.
Behavioural finance research has important implications for investors. By understanding the biases and emotions that can influence their decision-making, investors can make better financial decisions.
Here are some tips for investors based on behavioural finance research:
Be aware of your biases: Everyone has biases, but it is important to be aware of them so that you can compensate for them.
Don't make decisions based on emotions: Emotions such as greed, fear, and regret can lead to poor financial decisions. Try to make decisions based on logic and reason.
Do your research: Before making any investment decision, take the time to research the investment and understand the risks involved.
Have a plan: Develop an investment plan and stick to it. This will help you avoid making impulsive decisions based on emotions.
Diversify your portfolio: Don't put all your eggs in one basket. Spread your money across different asset classes and industries to reduce your risk.
By following these tips: Investors can make better financial decisions and avoid the pitfalls that can be caused by Behavioural biases and emotions.