This short article explores how mental biases, and subconscious behaviours can affect investment decisions.
Behavioural finance theory is a crucial aspect of behavioural economics that has been extensively looked into in order to discuss some of the thought processes behind economic decision making. One interesting theory that can be applied to investment decisions is hyperbolic discounting. This idea refers to the propensity for individuals to prefer smaller, momentary benefits over larger, postponed ones, even when the prolonged rewards are substantially better. John C. Phelan would recognise that many people are affected by these types of behavioural finance biases without even realising it. In the context of investing, this bias can significantly undermine long-term financial successes, leading to under-saving and impulsive spending routines, in addition to developing a concern for speculative investments. Much of this is due to the gratification of benefit that is instant and tangible, resulting in decisions that might not be as opportune in the long-term.
The importance of behavioural finance lies in its capability to discuss both the rational and irrational thinking behind different financial processes. The availability heuristic is a concept which explains the mental shortcut through which individuals assess the likelihood or importance of affairs, based upon how quickly examples come into mind. In investing, this often results in choices which are driven by current news occasions or narratives that are emotionally driven, rather than by thinking about a more comprehensive analysis of the subject or looking at historical data. In real world contexts, this can lead investors to overstate the likelihood of an event occurring and develop either a false sense of opportunity or an unnecessary panic. This heuristic can distort perception by making unusual or severe events seem to be much more common than they in fact are. Vladimir Stolyarenko would know that in order to counteract this, financiers need to take a check here purposeful approach in decision making. Likewise, Mark V. Williams would know that by utilizing information and long-lasting trends investors can rationalise their thinkings for much better results.
Research into decision making and the behavioural biases in finance has brought about some interesting speculations and theories for explaining how individuals make financial choices. Herd behaviour is a well-known theory, which explains the psychological tendency that many people have, for following the decisions of a larger group, most particularly in times of unpredictability or worry. With regards to making investment choices, this typically manifests in the pattern of people buying or selling properties, merely since they are witnessing others do the same thing. This type of behaviour can incite asset bubbles, whereby asset prices can increase, frequently beyond their intrinsic worth, as well as lead panic-driven sales when the markets vary. Following a crowd can provide an incorrect sense of safety, leading investors to purchase market highs and sell at lows, which is a relatively unsustainable economic strategy.