Broker Check
10 Basic Investing Principles - Principal 7 - Behavioral Finance

10 Basic Investing Principles - Principal 7 - Behavioral Finance

| April 26, 2023

Topic 7: Behavioral Finance

Behavioral finance is a field of study that combines principles of psychology with finance to better understand how people make financial decisions. It recognizes that humans are not always rational and that emotions, biases, and other psychological factors can influence investment decisions.

There are several common biases that can impact investment decisions. For example, confirmation bias is the tendency to seek out information that confirms preexisting beliefs, while loss aversion is the tendency to place greater weight on losses than on gains.

Another common bias is herd mentality, which is the tendency to follow the actions of the crowd rather than making independent decisions. This can lead to market bubbles and crashes, as investors may rush to buy or sell certain securities based on the actions of others.

Behavioral finance also recognizes the importance of framing, or the way information is presented, in investment decisions. For example, presenting investment returns as a percentage increase rather than a dollar amount can influence how investors perceive the value of the investment.

By understanding these biases and other psychological factors, investors can make more informed investment decisions. Working with a financial advisor can also help investors identify their own biases and develop a long-term investment plan that is aligned with their financial goals and risk tolerance.

In summary, behavioral finance highlights the importance of understanding how psychological factors can influence investment decisions. By being aware of common biases and working to overcome them, investors can potentially make more informed decisions and achieve long-term financial success.