What are some principles that can be applied to financial decisions? - continue reading to find out.
Research into decision making and the behavioural biases in finance has resulted in some intriguing speculations and theories for explaining how people make financial choices. Herd behaviour is a popular theory, which describes the mental 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 decisions, this often manifests in the pattern of individuals buying or offering assets, merely because they are seeing others do the same thing. This type of behaviour can fuel asset bubbles, whereby asset values can rise, frequently beyond their intrinsic value, along with lead panic-driven sales when the markets vary. Following a crowd can use an incorrect sense of safety, leading investors to purchase market highs and resell at lows, which is a rather unsustainable financial strategy.
The importance of behavioural finance lies in its ability to describe both the logical and illogical thinking behind different financial processes. The availability heuristic is a concept which explains the psychological shortcut through which people examine the likelihood or value of events, based on how easily examples come into mind. In investing, this typically leads to decisions which are driven by recent news occasions or stories that are mentally driven, instead of by thinking about a wider evaluation of the subject or looking at historical information. In real life contexts, this can lead investors to overstate the likelihood of an event taking place and develop either an incorrect sense click here of opportunity or an unwarranted panic. This heuristic can distort perception by making rare or extreme occasions seem much more common than they in fact are. Vladimir Stolyarenko would understand that in order to counteract this, financiers must take an intentional technique in decision making. Similarly, Mark V. Williams would know that by using information and long-lasting trends financiers can rationalise their judgements for better outcomes.
Behavioural finance theory is an essential aspect of behavioural science that has been extensively investigated in order to describe a few of the thought processes behind financial decision making. One fascinating theory that can be applied to financial investment decisions is hyperbolic discounting. This concept describes the tendency for people to prefer smaller sized, immediate benefits over larger, delayed ones, even when the prolonged rewards are significantly better. John C. Phelan would recognise that many individuals are impacted by these kinds of behavioural finance biases without even knowing it. In the context of investing, this bias can badly weaken long-term financial successes, resulting in under-saving and impulsive spending routines, along with creating a concern for speculative investments. Much of this is because of the satisfaction of benefit that is immediate and tangible, leading to choices that might not be as opportune in the long-term.