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Behavioral Finance

Behavioral Finance

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What is the difference between ‘regular’ finance and what has come to be called ‘behavioral finance?

Outcomes!

”Standard finance focuses on the outcomes of financial decisions, such as returns and risk.
Behavioral finance, on the other hand, focuses on both the outcomes and the process of making financial decisions including the impact of biases and emotions.”  Full article found here.

Understanding this decision process is a tall order

I am describing bias as the inclination to be comfortable with or lean towards those things or people like us or with whom we have experience.

I really like all college football. I have a bias towards the home team.

While stopped at a traffic light this weekend, a group of about 8 people crossed the street in front of my car. They were similarly dressed and spoke the same non-English language. They had a bias towards one another due to at least culture and language. They might also live in the same neighborhood or even be in the same family.

If in a group, you may notice that some people speak about their children. If you are a parent, you may have a bias towards those people regardless of other characteristics, such as ethnicity, race, economics, education, etc.

A bias is not intrinsically good or bad

I suspect that bias is inbred in humans as a safety instinct. We trust what we know and are cautious about those things or people that we don’t know.

It is helpful to know when our ‘bias’ is active in any situation, especially when it comes to investing.

Daniel Kahneman received a Nobel Prize for his work on sub-conscious bias in the way that people make financial decisions.

According to Kaplan, “efficient market hypothesis (EMH), a popular theory that the stock market moves in rational, predictable ways, doesn’t always hold up under scrutiny. In reality, the markets are full of inefficiencies due to investors’ flawed thinking about prices and risk.”

Also in the Kaplan article are the descriptions shown here of various biases in investing:

  • Self-attribution bias: Believing that good investment outcomes are the result of skill, and undesirable results are caused by bad luck.
  • Confirmation bias: Paying close attention to information that confirms a finance or investment belief and ignoring any information that contradicts it.
  • Representative bias: Believing that two things or events are more closely correlated than they really are.
  • Framing bias: Reacting to a particular finance opportunity based on how it is presented.
  • Anchoring bias: Letting the first price or number encountered unduly influence your opinion.
  • Loss aversion: Trying to avoid a loss more than on recognizing investment gains, so that desirable investment or finance opportunities are missed.

Which bias do you think you are prone to? How has it affected your investing outcomes?

Loss Aversion is a big one.

We help investors take the emotion out of investing by providing prudent stop loss calculations based on the recent results of every individual trending stock allowing the investor to concentrate on the opportunity for gains.

“My father gave me the greatest gift anyone could give another person, he believed in me.”
Jimmy Valvano, Coach

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