The field of behavioral finance has gained significant interest as more and more advice providers recognize that our own psychology plays a part in our own financial success.
We all have financial goals, and many of us struggle to meet them. It is easy to blame this on a lack of money, the stock market, or other factors, but in reality, our behavior and choices are often the biggest culprits.
|"Brilliant Investments Will Not Overcome Inadequate Saving."|
Behavioral finance is the study of the influence of psychology and how it can affect market outcomes. It focuses on the fact that humans are not always realistic, don't always practice restraint on their actions, and are influenced by their own beliefs and preferences, which leads to their decisions being flawed.
Traditional finance theory makes assumptions in its models that people/investors are rational actors, meaning they are free from being influenced by emotion or the effects of social relations or culture. In addition, it takes for granted that markets are efficient, and firms are impartial and adept in bringing in a profit. Behavioral finance pushes back against each of the beliefs.
Traditional Finance Theory
Behavioral Finance Theory
|Includes the following beliefs||Traits of behavioral finance|
|• The market and investors are rational||• Investors are looked at as "normal," not "rational"|
|• Investors care about physician features||• Investors are influenced by their own biases|
|• Investors have superb willpower||• Investors have limits to their self-control|
|• Investors are not thrown off by cognitive errors or information processing errors||• Investors can and will make a cognitive error that can lead to incorrect decisions|
*Investors referees to people making their own financial decisions
Behavioral finance can be evaluated from different perspectives. The study of behavioral finance can explain why an individual makes a particular financial decision and how their choices may affect markets. Remember, behavioral finance theory assumes that investors or financial participants are not perfectly rational, have limits to their self-control, and are influenced by their emotions, assumptions, and perceptions. And, these biases and irrational behaviors can have significant costs.
While the field of behavioral finance is broad and complicated, there are several concepts that most frequently impact success with money. There are five main concepts:
When you delve a little deeper, behavioral finance seeks to understand the impact personal bias and tendencies have on investors. Behavioral biases often lead people to make illogical or harmful choices around money. Common biases include:
When you understand how and when people may stray from rational decision-making and expectations, the study of behavioral finance can provide a model to help individuals make better, more rational decisions pertaining to their money and finances.
Is it possible to avoid or remain unmoved by your financial biases? Not really, at least not entirely. However, knowing that behavioral tendencies like these exist will help some. Here are a few other tips:
Behavioral finance attempts to measure misguided moves and decisions people make with their finances. Many of these financial behavioral biases are intrinsic in how someone thinks, feels, and processes information. However, there are ways for the investor to try to resist them. Several time-tested methods to improve the way you make decisions about your money include:
If you feel that your biases or preferences are clouding your decisions with money, reach out to one of our advisors. Spaugh Dameron Tenny helps dentists and physicians across the U.S. with holistic financial planning services.
Shane Tenny is the managing partner of Spaugh Dameron Tenny. Along with hosting the Prosperous Doc® podcast, Shane has a true passion for behavioral finance, helping clients and audiences understand how to develop successful strategies based on their unique temperaments. An accomplished and highly engaging speaker, Shane is regularly interviewed for television and podcasts, is actively involved in the Financial Planning Association®, and contributes to industry advisory boards.
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