Behavioral finance is the study of the effects of psychology on investors and financial markets. It focuses on explaining why investors often appear to lack self-control, act against their own best interest, and make decisions based on personal biases instead of facts. Behavioral finance programs come in many forms. Some are courses and course modules offered online training firms and universities. Others are professional programs offered traditional universities. Some universities offer accredited behavioral finance degrees, including bachelor of science, masters of science, and Ph.D. programs.
These programs also have all kinds of names—from “behavioral finance” to “behavioral economics and social health science.” They combine psychology and neuroscience with traditional financial practices. They aim to equip advisors with tools and training to further help their clients make sound financial decisions, maintain emotional competency, and achieve their financial goals.
Behavioral finance concepts
Behavioral finance typically encompasses five main concepts:
- Mental accounting: Mental accounting refers to the propensity for people to allocate money for specific purposes.
- Herd behavior: Herd behavior states that people tend to mimic the financial behaviors of the majority of the herd. Herding is notorious in the stock market as the cause behind dramatic rallies and sell-offs.
- Emotional gap: The emotional gap refers to decision-making based on extreme emotions or emotional strains such as anxiety, anger, fear, or excitement. Oftentimes, emotions are a key reason why people do not make rational choices.
- Anchoring: Anchoring refers to attaching a spending level to a certain reference. Examples may include spending consistently based on a budget level or rationalizing spending based on different satisfaction utilities.
- Self-attribution: Self-attribution refers to a tendency to make choices based on overconfidence in one’s own knowledge or skill. Self-attribution usually stems from an intrinsic knack in a particular area. Within this category, individuals tend to rank their knowledge higher than others, even when it objectively falls short.
Some Biases Revealed Behavioral Finance
Breaking down biases further, many individual biases and tendencies have been identified for behavioral finance analysis. Some of these include:
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