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What is Behavioral Finance?

What is Behavioral Finance?

January 06, 2020
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(Pictured: the “Fathers of Behavioral Economics” Amos Tversky, left, and Daniel Kahneman, right.)

Behavioral Finance is where the study of psychology meets with economics and finance. Recent studies, bestselling books from world class researchers and even Nobel Peace prizes suggest having a basic understanding of human behavior and our cognitive biases can help you succeed and stay successful as you plan and invest for your financial future.

Of the 597 Nobel Peace Prizes awarded since 1901, there have been 51 in economic sciences and three of those explicitly mention Behavioral Economics. Some of these have even led to changes in the way the world saves for their future, one example of this is automatic 401(k) plan enrollment where new hires at organizations actually have to opt out, rather than opt into retirement savings plans to avoid delay in their savings.

Harnessing positive behaviors and habits as an investor may help you succeed at very critical decision points. Part of these studies focus on human cognitive biases which affect how we respond to certain situations. One example is “recency bias” in which our brains highly value the most recent experiences or information we have available. For example, after a very strong market performance, recency bias would lead us to expect strong markets continue or on the contrary, after a weak or negative market performance, recency bias would lead us to expect weak or negative markets to persist. Either of these examples can lead to decisions that may not be appropriate based on risk tolerance or timeline that fit your personal and specific goals.

We appreciate the decades of hard work from those who went off the path of traditional psychology to study behavioral economics and give us a framework to apply for long term success.