Navigating the Maze of Financial Decisions: The Fascinating World of Behavioral Finance

The Rational vs. Emotional Investor  

Believe it or not, before behavioral finance came on the scene, it was assumed that investors make rational decisions based on complete information. However, when was the last time you felt like you had all the information about something? In the real world, there are several factors pushing all of us to make decisions, including emotions, cognitive biases, and social influences. 

For example, think of the last big market downturn. Did you look at the situation objectively and realize the most rational course of action was to invest more money while the market was down?  If so, bravo. You’re in the minority. Most investors might be tempted to panic, leading to terrible decisions that harm their long-term financial goals. That’s where your financial planner comes in. They help you recognize and manage those emotional reactions to keep you on track and help you achieve sustainable financial success. 

In order to get to know yourself better, let’s learn about a few of the most common biases: 

Anchoring bias 

It happens when you fixate on a specific piece of information and don’t consider new information that might cause you to make a different decision. Here’s an example. 

Imagine you’re making a choice of which new laptop to buy, and you really like the first one you see. You research lots of other laptops, but you can’t help comparing the price and features of all other laptops to that first one. That’s anchoring bias. When it comes to investing, you might get stuck on the first price of a fund you see. You become anchored to that price, and even if it’s a great investment, you may not be able to bring yourself to buy that fund for more than the original price you first encountered.  

With this bias, you can make a mistake either way: by paying too much for something because you put too much weight on one piece of information about it, or not buying something at all because of the first price you saw. To avoid these mistakes, it’s a great idea to look at lots of information, ask your financial planner for advice, and objectively think about something’s worth to you before investing your money in it. 

Herd mentality  

It is when people tend to think and behave conforming to others around them, rather than as individuals. As mothers would often ask, “if all your friends jumped off a cliff, would you do it too?” It turns out that in reality, the answer is (figuratively) yes. In fact, many people do. What they eat, wear, watch, and consume is driven in large part by what other people are doing, not what they should or even want to be doing. 

I’m sure you can see how this extends to investments. If the market is falling off the proverbial cliff, many investors also want to sell just as their fellow investors are doing. This ironically leads to larger market declines. On the flip side, if the market is climbing, many want to buy as their fellow investors are buying.  

And what do they want to buy? The stocks that have already soared, hence the saying that most investors buy high and sell low. The power of having a financial planner on your side is that they can prevent this bias from taking over your decision making. When you’re tempted to buy or sell, talk to your financial planner first! Also, ask yourself if it’s a decision being driven by big movements in the market. If the answer is yes, you’ve succumbed to herd mentality. 

Loss aversion

It is when people are so afraid of losing the money they already have that they might not want to try new ways of growing it, even if those ways are a really good idea. 

Let’s say you have a large amount of retirement savings in a money market account, yielding 2% interest. According to your financial plan, you need to make a larger return to not only meet your goals but simply keep up with inflation. However, you’re too afraid of losing money, so you can’t bring yourself to take any amount of risk for a potentially greater return. Because of this, your financial plan is in serious jeopardy. Your financial advisor can help by showing you how taking a little bit of risk now will fund your goals over the long term and educate you about the amount of risk you should take. Then they can invest your money in a way that helps you meet your goals while still letting you sleep at night. 

As you can see, we recognize that the path to your financial success is not just paved with numbers and charts, but it’s also shaped by human behavior and emotions. By combining traditional financial planning expertise with insights from behavioral finance, we empower you to make truly informed decisions that align with your goals and values. And for our financial planners, embracing the principles of behavioral finance is a key component in our mission to guide you toward a more secure and prosperous future.