As much as you hate the fact of growing old, that is bound to happen. And while you spend your early days just enjoying life, at this point, you need to safeguard your future. What better way to do that other than investing, right? It can be through acquiring assets like investing in real estate Philippines or entering the stock market and bonds. You are free to choose what industry you would want to invest in your future.
However, as easy as it may sound, investing is quite a complicated concept, and if not done properly, risks and challenges may cause further inconvenience. This is because there are several factors that you need to take into consideration before actually taking this big move. It can be market dynamics or economic situations but this article will talk about how your behavior directly affects your decision-making in investing.
Behavioral Finance & its Concepts
You may be good at making decisions based on your critical thinking skills enabling you to make valuable and effective decisions, however, there is no denying that most of the time, your decisions are highly influenced by emotions and behaviors. No matter how you evaluate things, you cannot always make rational decisions.
The study of Behavioral Finance rather proves this. It’s a theory under behavioral economics that explains how psychological factors combined with economic ones affect financial decisions. This sheds light on different biases and behaviors that people possess and exhibit when it comes to investing and making decisions in the financial markets.
Cognitive Behavioral Biases
To further understand behavioral finance, here are several concepts, and biases that help determine the psychological influences that directly and highly impact financial investing decisions.
Mental Accounting
Mental accounting explains how people determine the value of their money depending on how they are able to gain it. They categorized money into different “accounts” and based it depending on the source and intended use. However, this can lead to negative financial decisions as the weight of each money differs when in fact, it should all be the same.
Herd Behavior
Herd behavior refers to the tendency of people to mimic the decisions made by ‘herd’ or group of people. Instead of relying upon their willpower to decide, they follow someone’s path which usually leads to an irrational decision. While some succeed with this, it can result in market bubbles and losses.
Anchoring
This bias means that you base your judgments on some price or figures that you have seen before. Say, for example, you saw that the real estate Philippines is performing well so you expect it to still perform well in the future. This is a negative way of looking into things for you might be overvaluing or undervaluing the worth of a certain investment.
Emotional Gap
The emotional gap explains how investors typically rely their decisions on how they currently feel which leads to more irrational decisions. Since emotions fluctuate, it isn’t a good basis for decisions because what motivates you right now might not be effective next time.
Self-Attribution
Some people give off a ‘know-it-all’ vibe which is not a good thing in investing. This specific bias explains how some people tend to overestimate their knowledge and skills to the point that they don’t listen to professionals anymore, thinking that they know better than them.
Loss Aversion
Loss aversion works like a backup plan for investors when the original one doesn’t work. This means that instead of thinking about the potential gains, investors tend to put more emphasis and value on the possible incurred losses which cloud their rationality. It’s applicable when they hold onto a losing investment for far too long, wishing it would recover, or when they try to sell winning investments because they are afraid it may cause them more loss.
Confirmation bias
This bias explains that investors tend to put all their trust in their preexisting beliefs about something without considering if it’s wrong or right. They also exert efforts on finding proofs that will justify and support their thinking and usually stray far away from information that is opposed to what they believe in.
Experiential Bias
Also known as recency bias or availability bias, explains that an investor with this bias is most likely to rely their current decisions from previous events, with the thinking that if it worked last time, it will still surely work this time.
Familiarity Bias
This behavioral bias explains that rather than exploring an unknown market, investors tend to invest in an industry they already know or engage in to lessen incurring further risks.
Is it really important to overcome these Biases?
Yes. You as an investor who wants to succeed in this endeavor must overcome these biases. Doing so will allow you to invest without overthinking too much about potential risks, enabling your investment to even flourish. Moreover, getting past these biases will empower you to make rational, disciplined, and informed decisions, ultimately leading you to better investment outcomes.
Behavioral Finance: Pros and Cons
Taking extra steps to understand behavioral finance brings both pros and cons. Here are some of them to better guide you in this endeavor.
Gaining enough knowledge about behavioral finance allows you to understand yourself and your behavior, enabling you to avoid making rash decisions. In connection, you can recognize biases which leads to improved decision-making, allowing you to manage risks and avoid common pitfalls.
On the other hand, behavioral finance is complex and you will need time to delve deeper into its concepts so you can understand the theory better and put it to application effectively. Behavioral finance may also seem subjective as the behaviors of people typically vary. You may also find difficulty in having a balanced focus on psychology and investing, blurring the line of your decision-making.
Invest Wisely!
You want to safeguard your future, so might also think things through and consider several factors before coming up with a decision. Everyone can be an investor but only a few know how to do it effectively, minimizing losses and increasing potential gains. Don’t let your behavior and these biases stop you from investing in your future. Be educated and invest your hard-earned money wisely!
