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Behavioural finance – Understanding the science behind our investment choices

Author: Adam Sideserf
12 November, 2015


However, these days, that notion has largely been set aside in favour of a more evidence-based assessment that suggests we are, in fact, rather more irrational, community or family-oriented and not terribly disciplined when it comes to decision making. For example, how many of us continue to play the lottery every week even though we know that the odds of winning are stacked against us?

Being aware of our weaknesses

By realising that we aren’t instinctively going to be great at deciding how best to invest for the future, and understanding why that might be the case, we can look to overcome our deficiencies and make more logical, rational decisions about our finances.

Figuring out how this can be achieved relies on the work of behavioural scientists. This series of blogs will be looking in more detail at the outcome of extensive research carried out on behavioural science and how it influences our financial decision making.

Behavioural biases

The key to understanding behavioural science, at least as it relates to financial planning, is in understanding the biases that we all have a potential to display when it comes to making important decisions.

These behavioural biases vary in nature, impact and prevalence but they are crucial in this context because they can make a massive difference in influencing the way individuals might want to invest or avoid certain risks. Some of these biases may also explain the reluctance of many individuals to make any financial decisions at all.

Later in this series of blogs we will look in more depth at some of the most important and commonplace behavioural biases that investors can bring to the decision making process. But for now it is well worth noting that there are more than 150 such biases recorded and recognised among behavioural scientists with more being identified all the time.

One of the most recently discovered of these biases is referred to as the “Google Effect”, whereby contemporary investors don’t even bother to try to remember any information that they know they can find again easily through an internet search at just the click of a few buttons.

Working with clients in the real world

Even the top researchers and academics in the world disagree on exactly which of the behavioural biases that we display as human beings are beneficial to our purposes and which are counterproductive. So there is no sure-fire way to completely overcome or offset the potential effects of such biases among investors.

What everyone that interacts with the consumer can do though is to work closely with their clients to help them understand some of the most clear cut and appreciable biases in order to guide them effectively through the potentially unnerving process of choosing suitable investments which best meet their needs.

Key behavioural biases

Given that in today’s economic climate more and more financial decisions are being devolved to the consumer, there are 7 vitally important behavioural biases that we need to be aware of and they are as follows:

  1. Availability heuristic
  2. Regret avoidance
  3. Relative framing effect
  4. Anchoring effect
  5. Affect heuristic
  6. Conformity bias
  7. Risk illiteracy

Our upcoming blogs will take an in-depth look at each of these biases in turn and explain why they matter and what impact they can have on people’s investment decision making.