Learn how behavioral finance can help you change your life

Do you know how much behavioral finance influences your decisions?

Behavioral finance represents an area of study in economics that seeks to understand the reasons why people make certain financial decisions.

Most people know how important it is to save, save money and invest. However, in their daily lives, they often get carried away by their emotions. Consequently, they end up acting in the wrong way.

And if you want to be more conscious about your spending and savings, you need to understand more about behavioral finance.

In this article, we will explain everything about the subject. Keep reading!

What is behavioral finance?

Behavioral finance theory shows that there are several factors that can influence decision making.

In short, it is a very important choice, which can be influenced by anxiety, current concerns or even the opinions of third parties.

Therefore, an investor with a lot of knowledge and motivation can fail in the financial market if he does not have enough discipline to make investments.

Behavioral finance, as the name suggests, is entirely related to the economic sphere. However, psychology plays a major role in this concept.

Professionals in the field of psychology know that the vast majority of choices made by people are irrational.

However, in other times, economics and psychology were unable to create a “connection” point. It was only when psychology-based studies reached economics that this line of research was created.

Thus, professionals in the field began to study how human beings, in general, use emotions when dealing with money.

How did studies on behavioral finance emerge?

It took a long time for the terms “economics” and “psychology” to appear together.

This happened in the 20th century, through the work Economic Psychology by sociologist Gabriel Tarde.

But the issue only began to change around 1970, with research linked to behavioral finance.

Before studies on financial decisions began, science stated that humans were extremely rational when it came to using their money.

Scientists also said that people always choose the safest options. However, studies conducted by psychologists Daniel Kahneman and Amos Tversky have shown that this is not exactly what happens.

Psychologists and other professionals involved in the studies discovered that emotions, whether positive or negative, are related to the financial decision-making process.

In other words, this is why many people make wrong decisions when buying something or investing, for example.

Logical errors

Logical errors are studied within behavioral finance.

They are separated into two groups: biases and heuristics.

To better understand them, continue reading.

Cognitive biases

Cognitive biases are thinking tendencies that arise from social influences, distortion in memory storage, and emotional motivations.

In short, these are patterns of behavior that make us make completely wrong financial decisions.

There are more than 150 types of cognitive biases that interfere with the way we act and perceive reality.

Among them, we can mention:

• Confirmation: In confirmation bias, people ignore their own beliefs and are only interested in the information.

• Information: In this sense, people look for a large volume of information to find a solution to their problems. The problem is that the excess of information is not always enough for a person to decide something.

• Sunk cost: This bias explains how difficult it is for humans to abandon projects (even if they are not bringing results) after investing in them. In other words, it is a bias that studies the difficulty of letting go of something, even if deep down, the person knows they made a mistake.

Heuristic

Heuristics are strategies that reduce the time taken to make a decision and thus help to make a decision more quickly.

These are some types of heuristics:

• Affection: The affect heuristic involves choices that are influenced by a person's feelings at the time they are making a decision.

• Availability: In this case, the human mind establishes the probability of an event that happened in the past, whether positive or negative, happening again in the future.

What influences financial decisions?

There are many factors that influence the financial decisions you will make throughout your life.

In fact, it is very likely that many of your beliefs about money have emerged in childhood, because of the influence of their parents or acquaintances.

For this reason, it is very important that you start analyzing your behavior in relation to your finances.

Do you have difficulty saving? Do you frequently invest in the financial market without considering the risks involved?

There are several behaviors that can hinder your financial life, such as:

Loss aversion

Nobody wants to make a loss, right?

And that is why we create strategies to avoid financial losses. Obviously, this is completely related to the world of investments.  

On the one hand, there are investors who act completely impulsively. In other words, they do not consider the risks involved in a transaction, as they act in the heat of emotion.

On the other hand, there are those who are so afraid of losing money that they leave their money in savings accounts (or at home). Although it is safe, it has been proven that when it comes to profitability, savings accounts are not a good option.

Flock

Herd or flock behavior can undermine your decisions.

It is a pattern of behavior that refers to a collective but irrational action.

An example of this is when many investors start buying a specific stock because everyone is investing in it or someone influenced by it recommended a certain stock.

Conclusion

As you can see, behavioral finance has everything to do with your financial decisions, whether it's buying something, making an investment, among others.

For this reason, it is very important that you are aware of this fact, so that you can begin to understand what is behind your economic decisions!