Emotions have often been viewed as a weakness in investing and ignored in traditional investment models. Now, however, a shift seems to be taking place. Behavioral finance is gaining importance. In addition to trading and investment models, behavioral finance offers helpful guidelines for greater success in investing and investment counseling – especially for individual investors. What behavioral finance is and how it can help – here is an overview.
Whatever happened to Homo Economicus?
Neoclassical economic theory views us as Homo economicus – a person who reasons and acts strictly logically, is always fully informed, and strives to maximize profit with the least possible investment of time, labor, and capital. Do you recognize yourself in this description?
We rarely manage to make such rational decisions – especially when it comes to investing. Instead, our investment decisions are influenced by individual motives, attitudes, judgments, and the way we perceive and process information.
The daily flood of information
Did you know that the brain automatically ignores unnecessary information? Just like the second “that” in the previous sentence. Our brain filters content from the daily flood of information. In a single second, over 1 billion bits of stimuli flood toward us. Of these, we process about 15 million bits unconsciously and 60 bits consciously. This corresponds, for example, to a seven-digit phone number.
Optimized for our daily lives
Given our limited data storage capacity, it makes perfect sense to filter information. We are generally very good at selecting information. Our thinking and decision-making patterns are optimally tailored to our daily lives: rational and efficient. However, these same ingrained thinking and decision-making patterns can lead to catastrophic mistakes in abstract situations, such as investing. An example: Our selection of information is one-sided, and we miss signs of a trend reversal. Behavioral finance offers helpful tips on how we can avoid mistakes in abstract situations.
Achieve greater investment success with behavioral finance
Financial and stock market psychology takes our individual and emotional thinking and decision-making patterns into account. It combines finance and economics with social psychology and neuroscience. Behavioral finance not only explains how our thinking and decision-making patterns work but also how we can skillfully apply them to investing. Use the insights of financial psychology to make better investment decisions.
Author
Birgit Bruckner, MSc, CIIA
Freelance consultant and trainer
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